Optimal indexation of government bonds and monetary policy

Michael Hatcher (hatcherm@cardiff.ac.uk)
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Michael Hatcher: Cardiff Business School, http://www.southampton.ac.uk/socsci/about/staff/mch1m13.page

No E2011/3, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: Using an overlapping generations model in which the young save for old age using indexed and nominal government bonds, this paper investigates how optimal indexation is influenced by monetary policy. In order to do so, two monetary policies with markedly different long run implications are examined: inflation targeting and price-level targeting. Optimal indexation differs significantly under the two regimes. Under inflation targeting, long-term inflation uncertainty is substantial due to base-level drift in the price level. Nominal bonds are thus a poor store of value and optimal indexation is relatively high (76 per cent). With price-level targeting, by contrast, long-term inflation uncertainty is minimal because the price level is trend-stationary. This makes nominal bonds a better store of value compared to indexed bonds, reducing optimal indexation somewhat (26 per cent). Importantly for these results, the model captures two imperfections of indexation (indexation bias and lagged indexation) that are calibrated to the UK case.

Keywords: optimal indexation; government bonds; inflation targeting; price-level targeting (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2011-01, Revised 2011-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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