Optimal Fiscal Debt Management Strategy During Financial Crises: A Behavioral New Keynesian DSGE Approach for the US

Data shows that, the US Treasury has increasingly issued more long-term bonds to ?nance expenditures in the periods of ?nancial crisis, whose duration is comparatively higher than the pre-crisis periods. Using ad-hoc, partial equilibrium models, existing lit-erature explain this as a strategic debt management approach of the Treasury to mitigate their ?scal risk. By extending the model of De Grauwe and Foresti (2023) to incorporate bonds with varying maturity structures, we develop a behavioral New Keynesian model to explain debt management strategy of the Treasury by manipulating the duration of the long-term debts. The Treasury in our model optimally chooses the duration of its debt along with the tax rate to minimize the welfare loss. We show that increasing the duration of Treasury debt is optimal in the periods of ?nancial crisis when the traditional monetary policy is unproductive, as it generates an optimal trade-o¤ between the number of newly issued debt, and providing enough incentives to hold them by the banking sectors.