Publication
This thesis studies the pricing of government debt, federal and municipal, and its interaction with inflation and growth.
The first chapter studies how heterogeneous inflation rates due to differences in consumption baskets affect bond prices. Empirical evidence shows that both first and second moments of inflation vary considerably along the income distribution. To account for this I build a New Keynesian model with non-homothetic preferences, heterogeneous price rigidities, and Epstein-Zin utility. I find that yield spreads are sensitive to (i) whether central banks target an aggregate measure vs. an income specific measures of inflation, (ii) the marginal investor has an income elastic consumption profile or not, (iii) if productivity shocks originate in high or low inflation environments, and (iv) that the composition (real vs. inflation risk) is dependent on the investors consumption profile.
In the second chapter, we examine how interstate differences in fiscal rules can help explain the differences in municipal bond returns across US states in a dynamic equilibrium model of municipal credit risk. State governments choose the optimal level of debt and a default policy, taking as given a fiscal rule for taxes that depends on government indebtedness and state output. The municipal claims are priced by a risk-sensitive representative national investor. We calibrate the fiscal rules to approximate the impact of fiscal institutions on tax policy. We find that lower fiscal stringency predicts significantly higher expected municipal bond returns and debt levels across states, with a large fraction explained by a credit risk premium component that increases sharply in aggregate downturns. Overall, we show that fiscal institutions are an important determinant of municipal bond returns.
The third chapter investigates the implications of convenience yields for inflation and long-term growth in a model of the fiscal theory of the price level. The government's debt valuation equation links convenience yields to inflation and taxation, which affect the incentives to innovate. Convenience yields affect inflation through a standard seignorage channel as well as through a novel pricing channel in the presence of long-term debt. The model is solved globally using novel machine-learning techniques to approximate the policy functions. The calibrated model shows that both channels worked to reduce the effectiveness of monetary policy in the last decade and that discount rates are crucial to understand the implications of seignorage revenue for the real economy. Convenience yields thus emerge as a crucial variable to rationalize secular stagnation combined with high values of debt-to-GDP.