Author: Emilio Barone

Publisher:

Published: 2004

Total Pages: 22

ISBN-13:

The view put forward in this paper is that the index-linking of long-term public debt today represents a financial instrument that fosters a low average rate of inflation. In particular, bonds that are fully linked to the prices of a representative basket of goods and services permit a reduction in the inflation volatility risk premium, which weighs significantly on the nominal cost of the public debt and, ex post, gives rise to substantial real costs that distort the mechanisms of allocation and distribution and, ultimately, could lead to the debt becoming unsustainable. After re-examining the reasons for the orthodox aversion to index-linking - notably on the part of the monetary authorities of the more stable countries and especially the Bundesbank - the case is put for the leading industrial countries, and notably Italy, to issue index-linked government bonds. By issuing such bonds, the Treasuries of the various countries would send a strong stabilizing signal to the markets because recourse to the inflation tax in the future would no longer be advantageous, reduce the real cost of government borrowing by eliminating the inflation risk premium that currently has to be paid on issues with fixed nominal interest rates, benefit from the positive correlation between the quality of revenue and expenditure, and obtain valuable information on forward inflation rates and the real interest rates implicit in the prices of the bonds. The long-term real interest rate offered by index-linked bonds would act as a sort of lighthouse set up by the monetary authorities to illuminate the path of economic growth and enable operators and markets to coordinate their actions more effectively.