Working Paper: CEPR ID: DP10124
Authors: Andrew K. Rose
Abstract: 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.
Keywords: currency; domestic; effect; empirical; fixed; long; maturity; nominal; panel; risk
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| existence of a bond market (G10) | inflation rates (E31) |
| presence of a long nominal local-currency bond market in inflation-targeting countries (G15) | reduction in inflation rates (E31) |
| presence of a long nominal local-currency bond market in inflation-targeting countries (G15) | CPI inflation rate that is 2.9 percentage points lower (E31) |
| presence of a long nominal local-currency bond market in inflation-targeting countries (G15) | GDP inflation that is over four percentage points lower (E31) |