Working Papers
2015-05 | February 2015
More Working Papers
Domestic Bond Markets and Inflation
Abstract This paper explores the relationship between inflation and the existence of a local, nominal, publicly-traded, long-maturity, domestic-currency bond market. Bond holders are exposed to capital losses through inflation and therefore represent a potential anti-inflationary force; we ask whether their influence is apparent both theoretically and empirically. We develop a simple theoretical model with heterogeneous agents where the issuance of such bonds leads to political pressure on the government to choose a lower inflation rate. We then check this prediction empirically using a panel of data, examining inflation before and after the introduction of a domestic bond market. Inflation-targeting countries with a bond market experience inflation approximately three to four percentage points lower than those without one. This effect is economically and statistically significant; it is also insensitive to a variety of estimation strategies, including using political and fiscal variables suggested by theory to account for the potential endogeneity of domestic bond issuance. Notably, we do not find a similar effect for short-term or foreign-currency bonds.
Download PDF (pdf, 383.88 kb)
Article Citation
Rose, Andrew K, and Mark M. Spiegel. 2015. "Domestic Bond Markets and Inflation," Federal Reserve Bank of San Francisco Working Paper 2015-05. Available at https://doi.org/10.24148/wp2015-05