Debt redemption fund and fiscal incentives

We investigate a stochastic optimal control model for the management of public debt when part of the national debt is transferred to a Redemption Fund, which is allowed to finance itself in the market at a low interest rate, in exchange of the commitment to a fiscal consolidation plan by the national government both for the national debt and the Fund. The Fund is an interesting option for countries with high debt-GDP ratio and weak fundamentals. However, we show that it is not a free lunch in a sense that a country with a higher public debt should transfer a larger amount of resources to cut down the Fund. We calibrate the model to the experience of Euro zone countries with a high debt, showing that it is possible to design the mechanism allowing to pay back the Redemption Fund and stabilizing both the national debt and the fiscal surplus with a reduction of the fiscal effort. (c) 2023 Elsevier B.V. All rights reserved.