Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies

Ed Westerhout

Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies

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Abstract

Although inflation-linked bonds have many advantages, nominal bonds are
the most important instrument to finance public debts throughout the world.
One explanation that the literature has offered is that nominal bonds make
countercyclical monetary policies more effective. This paper reconsiders this
argument with a model that features an inflation risk premium in the nominal
bonds interest rate. In this model, nominal bonds help to stabilize the
economy, but also add to debt service costs. The paper finds that the debt
service costs channel is very powerful: in the case of discretionary policymaking,
inflation-linked bonds always outperform nominal bonds. The case of commitment qualifies this result. Still, also commitment cannot explain the occurrence of large stocks of nominal bonds alongside small stocks of inflation-linked bonds.

Original language	English
Place of Publication	Tilburg
Publisher	CentER, Center for Economic Research
Number of pages	42
Volume	2021-001
Publication status	Published - 4 Jan 2021

Publication series

Name	CentER Discussion Paper
Volume	2021-001

Keywords

Inflation-indexed Bonds
Time-Consistent Discretionary Monetary Policies
Stabilization Properties of Monetary Policies
Inflation Risk Premium

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2021-001Submitted manuscript, 519 KB

Connecting Organizations
Bekker, S. (Researcher), Bomer, A. (Researcher), Borghouts, I. (Researcher), De Pietro, C. (Researcher), Dusarduijn, S. (Researcher), Elsweier, F. (Researcher), Essers, P. (Researcher), Garcia Anton, R. (Researcher), Gribnau, H. (Researcher), Gubbels, N. (Researcher), Hoogeveen, M. (Researcher), Houwerzijl, M. (Researcher), Kaufmann, W. (Researcher), Kemmeren, E. (Researcher), Lafarre, A. (Principal Investigator), Lejour, A. (Researcher), Li, J. (Researcher), Loth, M. (Researcher), Mc Cahery, J. (Researcher), Montebovi, S. (Researcher), Peters, C. (Researcher), Rombouts, B. (Researcher), Russo, R. (Researcher), Staats, G. (Researcher), Starink, B. (Researcher), Steegmans, M. (Researcher), Stevens, S. (Researcher), Stevens, T. (Researcher), Sumner, I. (Researcher), Tjong Tjin Tai, E. (Researcher), Tzankova, I. (Researcher), Verbruggen, P. (Researcher), Vermeulen, E. (Researcher), Westerhout, E. (Researcher), Weterings, W. (Researcher), Wibier, R. (Researcher), Xu, D. (Researcher), Zegveld, C. (Researcher), Zekić, N. (Researcher), van Gulijk, S. (Researcher), van Hout, D. (Researcher), van Hulten, M. (Researcher), van Kempen, T. (Researcher), van Kesteren, H. (Researcher), van Vijfeijken, I. (Researcher), Van der Elst, C. (Researcher), Van der Sangen, G. (Researcher), Öner, C. (Researcher), Kryla-Cudna, K. (Researcher), Mak, V. (Researcher), Smit, D. (Researcher), Op Heij, D. (Researcher), Onţanu, E. A. (Researcher), Salah, O. (Researcher), Wijntjens, L. (Researcher), van Norden, G.-J. (Researcher), Vereijken-van den Bosch, S. (Researcher), Fernandez de Aranguiz Chueca, A. (Researcher), Diamant, Y. (Researcher), Geiregat, S. (Researcher), van der Burgt, B. (Researcher), Hofman, A. (Researcher) & Groeneveld-Tijssens, N. (Researcher)
1/01/19 → 31/12/23
Project: Research project

Cite this

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title = "Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies",

abstract = "Although inflation-linked bonds have many advantages, nominal bonds arethe most important instrument to finance public debts throughout the world.One explanation that the literature has offered is that nominal bonds makecountercyclical monetary policies more effective. This paper reconsiders thisargument with a model that features an inflation risk premium in the nominalbonds interest rate. In this model, nominal bonds help to stabilize theeconomy, but also add to debt service costs. The paper finds that the debtservice costs channel is very powerful: in the case of discretionary policymaking,inflation-linked bonds always outperform nominal bonds. The case of commitment qualifies this result. Still, also commitment cannot explain the occurrence of large stocks of nominal bonds alongside small stocks of inflation-linked bonds.",

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N2 - Although inflation-linked bonds have many advantages, nominal bonds arethe most important instrument to finance public debts throughout the world.One explanation that the literature has offered is that nominal bonds makecountercyclical monetary policies more effective. This paper reconsiders thisargument with a model that features an inflation risk premium in the nominalbonds interest rate. In this model, nominal bonds help to stabilize theeconomy, but also add to debt service costs. The paper finds that the debtservice costs channel is very powerful: in the case of discretionary policymaking,inflation-linked bonds always outperform nominal bonds. The case of commitment qualifies this result. Still, also commitment cannot explain the occurrence of large stocks of nominal bonds alongside small stocks of inflation-linked bonds.

AB - Although inflation-linked bonds have many advantages, nominal bonds arethe most important instrument to finance public debts throughout the world.One explanation that the literature has offered is that nominal bonds makecountercyclical monetary policies more effective. This paper reconsiders thisargument with a model that features an inflation risk premium in the nominalbonds interest rate. In this model, nominal bonds help to stabilize theeconomy, but also add to debt service costs. The paper finds that the debtservice costs channel is very powerful: in the case of discretionary policymaking,inflation-linked bonds always outperform nominal bonds. The case of commitment qualifies this result. Still, also commitment cannot explain the occurrence of large stocks of nominal bonds alongside small stocks of inflation-linked bonds.

KW - Inflation-indexed Bonds

KW - Time-Consistent Discretionary Monetary Policies

KW - Stabilization Properties of Monetary Policies

KW - Inflation Risk Premium

M3 - Discussion paper

VL - 2021-001

T3 - CentER Discussion Paper

BT - Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies

PB - CentER, Center for Economic Research

CY - Tilburg

ER -

Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies

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