Luca Zanotti

Debt management decisions have macroeconomic effects comparable to monetary policy. Using high-frequency movements in interest rate futures around U.S. Treasury issuance announcements, we identify a Treasury policy shock-an unanticipated change in public debt supply across maturities. A shock that raises the five-year Treasury yield transmits strongly to corporate borrowing rates, tightens credit conditions, and lowers industrial production significantly. These effects closely mirror those of a conventional monetary policy tightening. While long-term Treasury yields increase significantly, the shock has minimal effects on short-term interest rates. We show that this pattern reflects the Federal Reserve's sterilization of short-term Treasury issuance, while issuance at longer maturities is only partially offset.

We document a new fact: conditional on inflation and output, the Federal Reserve lowers the policy rate when the U.S. public debt-to-GDP ratio increases. To explain this pattern, we develop and estimate a New Keynesian model with shocks to households' demand for public debt. These shocks generate a negative comovement between public debt and the natural rate, defined as the real interest rate that would prevail under flexible prices. Assuming that the Federal Reserve adjusts its policy rate in line with the natural rate, the model rationalizes the negative relationship between debt and the policy rate. Two complementary exercises support this mechanism. First, we show that shocks to the demand for public debt are a key driver of business cycle fluctuations. Second, we construct a debt-informed measure of the natural rate using a time-varying parameter vector autoregression. When this measure is included in the policy rule, an increase in the debt-to-GDP ratio no longer reduces the policy rate.