The Optimal Currency Composition of Government Debt

Against the background of the increasing issues of government bonds in the United States and European countries, debt management policy has recently been receiving increasing attention. This paper questions the current practice of the United States, the largest debtor nation in the world, of continuing to issue government bonds denominated in its own currency. Based on the assumption that goods prices are sticky, we derive a formula for the optimal currency composition of government debt that maximizes the welfare of the U.S. private sector. The optimal currency composition computed under realistic parameter values suggests that one way to increase U.S. economic welfare is to continue issuing almost 100% of short-term bonds in the U.S. dollar and at the same time to reduce the share of the U.S. dollar in long-term bonds.