Working Paper: NBER ID: w15014
Authors: John Y. Campbell; Robert J. Shiller; Luis M. Viceira
Abstract: This paper explores the history of inflation-indexed bond markets in the US and the UK. It documents a massive decline in long-term real interest rates from the 1990's until 2008, followed by a sudden spike in these rates during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation- indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing going forward, even though they have offered high returns over the past decade.
Keywords: inflation-indexed bonds; real interest rates; financial crisis; liquidity; bond markets
JEL Codes: E43; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| institutional factors (D02) | inflation-indexed bond yields (E31) |
| unwinding of large institutional positions (G23) | spike in inflation-indexed bond yields (E31) |
| inflation-indexed bonds (E31) | hedge against equity risk (G12) |
| stock market volatility (G17) | desirability of inflation-indexed bonds (E31) |
| short-term real interest rates (E43) | inflation-indexed bond yields (E31) |
| risk premiums negatively correlated with consumption and stock prices (D11) | inflation-indexed bond yields (E31) |
| low short-term real interest rates + risk premiums negatively correlated with consumption and stock prices (E44) | long-term real interest rates (E43) |