Article | Review of International Economics | 2009

Debt Maturity: Is Long-Term Debt Optimal?

by Laura Alfaro and Fabio Kanczuk

Abstract

We model and calibrate the arguments in favor and against short-term and long-term debt. These arguments broadly include: maturity premium, sustainability, and service smoothing. We use a dynamic equilibrium model with tax distortions and government outlays uncertainty, and model maturity as the fraction of debt that needs to be rolled over every period. In the model, the benefits of defaulting are tempered by higher future interest rates. We then calibrate our artificial economy and solve for the optimal debt maturity for Brazil as an example of a developing country and the U.S. as an example of a mature economy. We obtain that the calibrated costs from defaulting on long-term debt more than offset costs associated with short-term debt. Therefore, short-term debt implies higher welfare levels.

Keywords: Borrowing and Debt; Investment Return; Development Economics; Taxation; Risk and Uncertainty; Cost; Interest Rates; Developing Countries and Economies; Welfare or Wellbeing; United States; Brazil;

Citation:

Alfaro, Laura, and Fabio Kanczuk. "Debt Maturity: Is Long-Term Debt Optimal?" Review of International Economics 17, no. 5 (2009): 890–905. (Also Harvard Business School Working Paper, No. 06-005 and NBER Working Paper No. 13119.)