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.


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