Government Debt Limits and Stabilization Policy

We evaluate alternative public debt management policies in light of constraints imposed by the effective lower bound on interest rates. Replacing the current limit on gross debt issued by the fiscal authority with a limit on consolidated debt of the government can ensure that output always reaches its potential, but it may permit excess government spending when the economy is away from the effective lower bound. The welfare-maximizing policy sets the gross debt limit to the level implied by Samuelson (1954), while the central bank finances government spending with money when the economy is at the effective lower bound.