Luca Zanotti

Debt management decisions have macroeconomic effects comparable to those of monetary policy. Using high-frequency movements in Treasury futures around U.S. Treasury issuance announcements, we identify a Treasury policy shock—an unanticipated change in the supply of public debt across maturities. A shock that raises the five-year Treasury yield increases corporate borrowing rates, tightens financial conditions, and lowers industrial production. These effects are very similar to those of a conventional monetary policy shock. In this sense, the Treasury does monetary policy. In contrast to a monetary policy shock, our Treasury policy shock has minimal effects on short-term rates. This pattern arises because the Federal Reserve sterilizes the issuance of short-term debt, while only partially offsetting issuance at longer maturities.

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.