The Politics of Index‐Linked Bonds

Abstract

In this paper we will seek to provide a political economy explanation for the government issuance of indexed bonds. We will show that the issuance of nominal bonds decreases in¯ation whenever the bondholders' constituency is stronger than the taxpayers' constituency. We then assume that public debt management is in¯uenced by the Central Bank. Contrary to what is predicted by the traditional time-inconsistency approach, we show that when the creditor constituency is more powerful than the taxpayers' constituency, by oering in¯ation protection through the issuance of indexed bonds the Central Bank reduces the creditors' eorts against in¯ation and thereby raises equilibrium in¯ation.

How is the Debt Managed? Learning from Fiscal Stabilizations

“…Finally, our findings cast doubts on the relevance of debt management theories which stress the strategic use of debt instruments; see e.g. Milesi-Ferretti (1995), Uhlig (1997) and Pecchi and Piga (1999). In particular, governments do not appear to issue long maturity debt in order to increase bondholders' political support for anti-inflationary policy and fiscal restraint.…”

“…MilesiFerretti (1995), Uhlig (1997) and Pecchi and Piga (1999). In particular, governments do not appear to issue long maturity debt in order to increase bondholders' political support for anti-inflationary policy and fiscal restraint.…”

Is there any scope for corporatism in macroeconomic policies?

“…On the other hand, if unions are political associations close to political parties, union leaders can promote or combat inflation in the attempt to influence the political business cycle (Detken and Gärtner 1994;Alvarez et al 1991). If creditor and debtor lobbies are introduced in a world without indexation, unions may be favorable to inflation as it erodes the real debt of the debtors, under the assumption that they are more represented in their membership than in the society (Pecchi and Piga 1999). For similar reasons, if the union membership is formed by pensioners more than by workers, union leaders can rationally fight against inflation (as pensions are not indexed) and exchange wage moderation for social reforms (Cukierman 2004).…”

The behavior of government of Canada real return bond returns

“…If unexpected inflation is negatively correlated with output shocks while government budget positions are positively correlated with output shocks, a government that has index-linked debt outstanding may thus find that its debt service costs are high when its revenues are low, and visa versa. Pecchi and Piga (1997) also mention that the hedging properties of nominal bonds as one of the seven reasons for the shortage of indexlinked bonds. Missale (1997) empirically tested this argument for Italy and the UK; he found that issuing nominal debt was more useful in hedging macroeconomic shocks in Italy, but not in the UK.…”