The Bond Market: An Inflation-Targeter's Best Friend
This paper explores the relationship between inflation and the existence of a publicly-traded, long-maturity, nominal, domestic-currency bond market. Bond holders suffer from inflation and could be a potent anti-inflationary force; I ask whether their presence is apparent empirically. I use a panel data approach, examining the difference in inflation before and after the introduction of a bond market. My primary focus is on countries with inflation targeting regimes, though I also examine countries with hard fixed exchange rates and other monetary regimes. Inflation-targeting countries with a bond market experience inflation approximately three to four percentage points lower than those without a bond market. This effect is economically and statistically significant; it is also insensitive to a variety of estimation strategies, including using political and fiscal instrumental variables. The existence of a bond market has little effect on inflation in other monetary regimes, as do indexed or foreign-denominated bonds.
The data set, key output, and a current version of this paper are available at my website. For comments and help, I thank: Sumit Agarwal, Shaheen Bhikhu, Ross Levine, Andrew Scott, Mark Spiegel, and Alan Taylor. For hospitality during the course of writing this paper, I thank the Bank of England and the National University of Singapore. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.