Why no gdp-indexed bonds?

Might some eurozone nations benefit from gdp-indexed bonds?  Imagine if required bond payments went down when your gdp went down, thereby providing some insurance against bad economic times.  Here is a good summary blog post of the idea.  Here are other writings on the idea.  Alternatively, you might also ask why governments don’t find ways, indirect ways if necessary, to issue equity shares.

Yet we hardly ever see these instruments, although Argentina and Greece have tried what are arguably variants on the idea (pdf.)  Why not?  I can think of a few reasons:

1. Nations might falsify their gdp figures.  Yet I am not sure it is the fundamental reason, since you can imagine the contracts based on more objective gdp correlates, such as prices taken from securities markets or prediction markets.

2. Signaling and adverse selection reasons make large, highly scrutinized entities reluctant to buy explicit, blatant insurance against their own failures.

3. There is no missing market here, because governments could always — either directly or indirectly — short themselves in the CDS market.  See #2 for a caveat.

4. Prosperous and creditworthy nations do not need the bonds, and the less secure nations will encounter costs from splitting the liquidity of their government bonds market.

5. Most governments do not run big budget surpluses in good times, even though they should.  The absence of gdp-linked bonds is a corollary of this failure and the consumption return profiles of those two options are remarkably similar.  In any case if a government has the discipline to forsake cash in good times, to save it up for bad times, as for instance Chile and Norway have shown, savings are easier than the gdp-indexed bonds.  Alternatively a profligate will neither save nor buy insurance.

Most of all, I say #5.


6. Governments have been able to sell existing bonds at an artificially low price because capital standards rules treated them as risk-free. Explicitly linking them to gdp would deprive them of this benefit.

7. Politicians signing the loan documents don't care much about the future costs of repayment in the bad situation as it falls on taxpayers as a whole, not on them personally. You can tie this in with those politicians who do care, have the discipline to save anyway.

5. Most governments do not run big budget surpluses in good times, even though they should

We're all Keynesians now.

IMHO government bonds that aren't repaid immediately the next time taxes are collected should be outlawed, since they are an obvious Ponzi scheme.

All past politicians who issued them need to given lifetime jail sentences, confiscation of all their properties and perhaps torture.

For obverse of the same reason outlined by TC I've read Chinese (and Greeks) don't buy fire insurance. If you need insurance, you are going to act negligently, whereas if you know you don't have insurance you'll be more prudent. In addition, they build with concrete and wet gypsum in Greece, and rarely with wood so even if your sofa catches on fire, likely it will not burn down the building. Freak-o-nomics.

OT--I'm on top of the world, as I just beat a titled player in the Ruy Lopez, in a serious game for money at the local chess club. No clock, no time trouble, I just drifted into a winning position that got better with time.


Because debt investors do not want equity-like instruments

Said another way: the interest rate would be too high

Indeed. Last I checked, a market has both sellers *and* buyers. I think it's very telling that *all* of Tyler's reasons and most of these comments focus on the reasons the government has for not offering these, without considering the role creditors play in the decision. (Because of course creditors can't do anything wrong).

In a 2005 IDB report written with Eduardo Borensztein, Barry Eichengreen and Eduardo Levy Yeyati we wrote something which is related to point 5. In particular, we concluded that:

Finally, obtaining some form of market insurance, either through derivative contracts or
through indexed debt, must also surmount a more fundamental obstacle. By its very nature,
any such device implies a cost that must be paid during good times. This is analogous to
paying an insurance premium and takes the form of losses in a futures or option contract
or high coupon payments on debt. As these contracts are relatively complex, such losses
can be easily misunderstood and become politically costly. This creates little incentive for
politicians to enter into large-scale contracts of this type, especially for myopic politicians,
considering that the cost is likely to be paid up front but the payoff from the insurance may
accrue only years later.

In other parts of the report we also discuss the in theory self-insurance (ie SWF) is less efficient than indexed debt.
If anybody is interested, the report is at: http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=1581016 The discussion on "safer" debt instrument is in Chapter 14

Under nominal GDP level targeting a fixed rate bond would have the same real obligations as a GDP-linked bond under a price level targeting regime. These instruments would become the norm.

This seems to me one of the biggest benefits of NGDP targeting, not just for governments selling bonds but also for firms whose ability to repay will have a large part of the systemic risk removed.

8. Moral hazard. If your austerity program fails or you want to veto growth projects for environmental reasons, you are rewarded with a drop in payments. Would you expect to see a market for mortgages where payments automatically drop along with the borrower's income?

"Most governments do not run big budget surpluses in good times, even though they should."

And therein is revealed the sort of atrophied ideology of neo-leftists. The whole "government as a paternalistic entity" is the domain of neo-leftists--such as Cowen and Krugman--even if that seizure of control provides a disincentive to the creation of wealth in private enterprise. It really is a filthy philosophy by which to advocate for failed (and ever-failing) ideology. But reality never dissuades wannabe socialist trash from their dystopian fantasies.

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