Can eliminating the stock of government bonds reduce welfare? When the government must raise revenue to pay interest on its
bonds, the social value of government debt hinges on whether the benefits from greater portfolio diversification outweigh
the costs of the revenue-raising efforts. A positive stock of debt is optimal only if interest payments are financed by an
inflation tax, agents are not too risk averse, there is a government budget deficit, and the economy is on the bad side of
the Laffer curve. Welfare is higher on the good side of the Laffer curve without bonds.
Keywords Government debt - Fiscal policy - Monetary policy - Portfolio allocation
JEL Classification Numbers E0 - E4 - E5 - E6 - H6 - G1
This paper was finished after Bruce Smith’s death. The authors thank Kevin Huang, Jim Bullard, Mark Gertler, and Antoine Martin
for helpful comments. Aarti Singh provided exceptional research support. The views expressed in this paper are not necessarily
those of the Federal Reserve Bank of Kansas City or the Federal Reserve System.