Working Papers

2015-09 | August 2015

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Bond Vigilantes and Inflation

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We explore the relationship between inflation and the existence of a local domestic‐currency bond market. Domestic bond markets allow governments to inflate away their debt obligations, but also create a potential anti-inflationary force of bond holders. We develop a simple model where bond issuance may lead to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically, finding that inflation‐targeting countries with bond markets experience inflation approximately three to four percentage points lower than those without. This effect is insensitive to a variety of estimation strategies and methods to account for potential endogeneity.

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