CFDP 1696

Understanding Inflation-Indexed Bond Markets

Author(s): 

Publication Date: March 2009

Pages: 47

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: 

Expectations hypothesis, Liquidity, Terms premia, TIPS

JEL Classification Codes:  E43, E44, G12

Note: 

Published in Brookings Papers on Economic Activity (Spring 2009), 79-120 [DOI]