Guest post: GDP-Linked Bonds (by David Eagle)
Guest post: GDP-Linked Bonds, Another Whole Literature to Synthesize into Market Monetarismby David Eagle As Dale Domian and I have been frustrated at our continuous attempts to publish our quasi-real indexing research, I have kept reminding myself of one thing and that is that we were the first to design quasi-real indexing (Eagle and Domian, 1995. "Quasi-Real Bonds--Inflation-Indexing that Retains the Government's Hedge Against Aggregate-Supply Shocks,” Applied Economic Letters). However, I have recently encountered some good news and some bad news concerning quasi-real indexing. First, the bad news: It turns out that Dale and I were not the first to come up with the notion of quasi-real indexing. Somebody actually beat us by two years. The reference is is Robert Shiller's "Macro Markets: Creating Institutions for Managing Society's Largest Economic Risks". Actually, Shiller did not use the term “quasi-real indexing.” Instead, he used “GDP-linked bonds.” Shiller shares the same origins for these bonds as Dale and I do. We all started thinking about government bonds. At the time of our 1995 paper, the U.S. government was considering inflation-indexed bonds. Instead, we proposed an alternative bond that would be safer for the government. Unfortunately, the U.S. government decided to issue TIPS, an inflation-indexed bond, rather than either Shiller’s proposal or Dale’s and my proposal. Now the good news: A significant literature has evolved concerning GDP-linked bonds. The existence of this literature provides the market monetarists another literature to bring into the Market Monetarism literature. In particular, I have come to recognize that quasi-real indexing basically provides insurance against the central bank not meeting its nominal GDP target even if the central bank is not targeting GDP. If those in the GDP-linked-bond literature can recognize that that is what their GDP-linked bonds do, they will then realize that George Selgin was right in Less than Zero about how risk on loans should be shared between borrowers and lenders. Also, they should realize that nominal bonds will achieve the same effect as GDP-linked bonds as long as the central bank successfully targets nominal GDP. You can find GDP-linked bonds in Wikipedia; unfortunately, you cannot find “quasi-real indexing” there (yet). More recently Professor Shiller joined Mark Kamstra in a paper proposing “Trills,” which are a GDP-linked bond. Other literature concerning GDP-linked bonds include: Mark Kamstra and Robert J. Shiller: “The Case for Trills: Giving Canadians and their Pension Funds a Stake in the Wealth of the Nation.” Kruse, Susanne, Matthias Meitner and Michael Schroder, “On the pricing of GDP-linked financial products.” Applied Financial Economics 15: 1125-1133, 2005. Griffith-Jones, Stephany, and Krishnan Sharma, “GDP-Indexed Bonds: Making It Happen.” DESA Working Paper No. 21, 2006. Schröder, Michael; Heinemann, Friedrich; Kruse, Susanne; Meitner, Matthias; “GDP-linked Bonds as a Financing Tool for Developing Countries and Emerging Markets” Travota, Alexandra “On the Feasibility and Desirability of GDP-Indexed Concessional Lending,” Also, some blog posts exist on GDP-linked bonds: Jonathan Ford: The Case for GDP Bonds Alex Tabarrok: GDP-Linked Securities Also, a very recent blog post in the WSJ.com just covered Robert Shiller’s proposal of these GDP-linked bonds: "Worried About U.S. Debt? Shiller Pushes GDP-Linked Bonds" I myself am still reading these other papers, books, and blog posts. The reality is that if not only the U.S. government issued quasi-real bonds or GDP-linked bonds, but also European governments issued them as well, then the European sovereign debt crisis would not be at all as serious a problem as it is today. Also, as most market monetarists know, if the European Central Banks had been targeting nominal GDP successfully, then the European sovereign debt crisis would be of a much smaller magnitude than it has become. Paul Krugman has noted how the increase in European sovereign debt coincided with the beginning of the last recession. I hope that Professor Krugman will look into the GDP-linked-bond and quasi-real-indexing literatures to learn how these types of bonds would have prevented this increase to happen. Actually, Argentina has recently issued some GDP-linked bonds as one of the above blogs points out. In economics, we have a lot of unconnected literatures that needs to be brought together. Obviously, Dale and my “quasi-real indexing” needs to be synthesized into the GDP-linked bond literature. However, synthesizing both of these literatures along with the wage-indexation literature and the nominal GDP targeting literature leads to the incredible conclusions: (1) Much of the Pareto-efficiency associated with complete markets can be achieved either through quasi-real indexing of all contracts or by the central bank (successfully) targeting nominal GDP, (2) Most of the negative economic effects of the business cycle would be eliminated either through quasi-real indexing or nominal GPD targeting. I hope this post encourages those involved in the GDP-linked bond literature, wage indexation literature, and the literature on NGDP targeting to work on synthesizing all of their literatures together.
© Copyright (2012) by David Eagle