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Title:Optimal indexation of government bonds and monetary policy PDF Logo
Authors:Hatcher, Michael C.
Issue Date:2011
Series/Report no.:Cardiff Economics Working Papers E2011/3
Abstract:Using an overlapping generations model in which the young save for old age using indexed and nominal government bonds, this paper investigates how optimal indexation is influenced by monetary policy. In order to do so, two monetary policies with markedly different long run implications are examined: inflation targeting and price-level targeting. Optimal indexation differs significantly under the two regimes. Under inflation targeting, long-term inflation uncertainty is substantial due to base-level drift in the price level. Nominal bonds are thus a poor store of value and optimal indexation is relatively high (76 per cent). With price-level targeting, by contrast, long-term inflation uncertainty is minimal because the price level is trend-stationary. This makes nominal bonds a better store of value compared to indexed bonds, reducing optimal indexation somewhat (26 per cent). Importantly for these results, the model captures two imperfections of indexation (indexation bias and lagged indexation) that are calibrated to the UK case.
Subjects:optimal indexation
government bonds
inflation targeting
price-level targeting
JEL:E52
E58
Document Type:Working Paper
Appears in Collections:Cardiff Economics Working Papers, Cardiff Business School, Cardiff University

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