Improving Public Debt Management
In the OIC Member Countries
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Zealand. Since 1997, the New Zealand’s DMO has been part of its Asset and Liability
Management Branch and in Australia it is called Office of Financial Management.
Coordination with monetary policyUntil the 1980s, public debt management was mainly considered to be part of monetary policy.
When debt levels in many OECD countries were rising during the 1970s and 1980s as a
consequence of expansionary macroeconomic policies, debt management was considered a
choice between inflation financing and debt issuance. Debt management offices operated as
departments of central banks and governments controlled the supply of central bank liabilities
in order to finance their expenditures – a phenomenon known as fiscal dominance.
Academic research as well as the experience of high and costly inflation rates in the 1970s and
1980s led to a rethinking of central banking: a consensus emerged that independent central
banks equipped with a clear mandate for price stability – such as an inflation targeting
framework – are important commitment devices. Many studies found a negative relationship
between inflation and central bank independence (see Cukierman 1992, Eijffinger and de Haan
2016). The separation between monetary and fiscal considerations often included the legal
prohibition for central banks to purchase government bonds. As an example, the Treaty on the
Functioning of the European Union (2012) prohibits the European Central Bank to provide
overdraft facilities to public entities and to purchase sovereign bonds directly on the primary
market (Article 123).
Fiscal financing may give rise to excessive money growth, which then causes inflation
according to the quantity theory of money. Besides this inconsistency between debt
management and a price stability objective, there are other conflicts of interests if the central
bank manages public debt:
1) Level of inflation: the central bank might target an inflation rate that is higher than what is
optimal for the aggregate economy in order to inflate away the real value of debt.
2) Interest rate reaction: the central bank might be reluctant to raise interest rates even if
this is indicated by standard monetary reaction functions. Higher interest rates would
increase interest payments on public debt and contribute to a higher level of public debt.
3) Manipulation of financial markets: the central bank might align the timing of monetary
policy with its debt management. If it injects liquidity just before the issuance of
government bonds, this will lower their yields. Moreover, the maturity and currency
structure of government debt might be chosen to support monetary policy.
4) Time horizon: while monetary policy is guided by shortterm considerations, debt
management optimally has a longer planning horizon.
A clear allocation of the responsibilities for monetary policy and debt management, which is a
precondition for accountable institutions, suggests dividing these policies between two
institutions. As an example, this reasoning accounted for the decision to transfer the British
debt management from the Bank of England to a DMO within the Treasury in 1998.