Public confidence and debt management: a model and a case study of Italy

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Abstract
Introduction With a public debt projected to remain close to 100% of GNP for several years in the future, the Italian authorities face two goals: first, to keep the cost of debt service as low as possible; second, to guarantee monetary and financial stability while carrying out the financial liberalization required by the EC accords. This paper investigates the role of public debt management in the achievement of these two goals. Section 2 of the paper briefly summarizes the debt management policies followed in Italy during the 1980s. Even though in the first half of the decade these policies were quite successful, they may have planted the seeds of the difficulties of the Summer of 1987, which marked a turning point. Unlike in the pre-87 period, the government has been unable to issue long-term debt at low cost. A difficult dilemma has arisen: should the government pay a premium in order to prevent a shortening of the maturity of its debt; and what kind of debt instruments should be issued? The answers to these questions depend on the nature of the risk premium currently paid on long-term debt. Section 3 asks whether the return on the Italian public debt currently incorporates a premium against the risk of a confidence crisis, or more generally of a government default. This is a difficult question, and any attempt to answer it must be regarded as tentative and not conclusive.

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