We model and calibrate the arguments in favor and against short-term and long-term debt. These arguments broadly include: maturity-term premium, tax smoothing, rolling over risk and the cost from defaulting. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and model maturity as the fraction of debt that needs to be rolled over ever period. In the model, the benefits of defaulting are tempered by higher future interest rates. We obtain that the calibrated costs from defaulting long-term debt more than offset other costs associated with short-term debt. Therefore, short-term debt implies in higher welfare levels.
Debt Maturity: Is Long-Term Debt Optimal?