Archived - Evaluation of the Government’s Decision to Target a Higher Fixed Rate Debt Structure

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Context

The Department of Finance values the work of Professors Roberts and Gottesman in the preparation of this report and is moving to address the issues raised by their recommendations.

We are pleased to note that Professors Roberts and Gottesman expressed the opinion that Canada’s debt strategy and objectives are consistent with the best practices of other sovereigns and also with current academic literature. The recommendations presented here are summaries, approved by the author, of issues raised in the document above. Specific management responses to the issues raised are:

1. Canada’s fixed-rate debt is proportionally smaller than that of most other countries, suggesting that Canada’s debt profile is less prepared for supply shocks than other countries. It would be useful to review rollover risk and conduct a comparative survey of redemption profiles across countries. In addition, rollover risk should be incorporated in the Government’s analytical framework.

Department Response

The maturity profile of the federal debt reflects the Government’s decision to structure it in a way that balances lower financing costs with reasonable cost stability and lower refinancing risk under a range of potential interest rate environments over the long term. The target debt structure is not based on a particular interest rate outlook but rather a prudent evaluation of the range of possible scenarios.

The Department also maintains an active interest in the debt policies of comparable sovereign countries in order to ensure that it benefits from experiences abroad as well as domestically. While sovereign debt structure comparisons are complicated by data definitions, recent meetings with other debt managers suggest that the redemption profiles of comparable sovereigns have been reduced over the last few years.

Beyond this, the Department is taking more explicit steps to address the issue of rollover risk more comprehensively through the incorporation of additional measures such as fixed-floating ratio and duration in its analytical framework and through more in-depth study of the implications of changes in the average-term-to-maturity of the debt.

2. The Government should extend its quantitative methodologies and their applications and recognize more explicitly the limitations of techniques employed.

Department Response

Current work is focussing on improvements in modelling techniques. As modelling techniques evolve, new quantitative methodologies will be incorporated.

3. The Government should enhance the interest rate and economic models by creating analytical links among the surplus or deficit position of the Government, the evolution of the term structure and general economic conditions.

Department Response

Recent work by the Bank of Canada on the modelling of the fiscal impact of interest rate changes is addressing this recommendation.

4. The Government should incorporate alternative fiscal scenarios into its analytic models.

Department Response

Recent work by the Bank of Canada on the modelling of the fiscal impact of interest rate changes is addressing this recommendation.

5. The Government should move to speed up its computer model, which currently requires eight hours to run.

Department Response

Current work is focussing on improvements in modelling techniques. An important aspect of this work is improving the capacity to assess a broader range of economic scenarios in a more timely fashion. Work done by the Bank of Canada, together with the Department of Finance, has already greatly reduced the time required to run the existing model. Other work continues on improving modelling of a more simplified representation of the debt structure.

6. The Government should conduct a back-casting exercise to verify the utility of its model through the use of historical data.

Department Response

The Department is planning to undertake back-casting work in the near future.

7. The Government should consider expanding derivative use to manage risk.

Department Response

Derivatives (interest rate swaps) have been used to manage risk in the past. However, the Department has concerns about the potential impact on financial markets and how transparency can be maintained given the large size of the debt stock. The Government currently prefers to manage the debt structure through adjustment of its primary issuance of various types of securities. The desirability of using swaps for debt structure management is reviewed periodically.