Why Investors Prefer Nominal Bonds: a Hypothesis
Date
2007-05
Authors
Coleman, William
Journal Title
Journal ISSN
Volume Title
Publisher
Centre for Economic Policy Research (CEPR), Research School of Social Sciences, The Australian National University
Abstract
The paper advances an answer to a puzzle: Why is any lending or borrowing done in
terms of money, when such money debt exposes the lenders’ wealth to inflation risk? The
‘received’ answer to this question is that money bonds are just proxies for real bonds,
proxies born of insufficient appreciation, or a benign neglect, of inflation risk. As mere
‘proxies’, this answer implies that money bonds are redundant: anything a money bond
could do, a real bond could do. The thesis of the paper is that money bonds are not
redundant. Money bonds have a social benefit. That benefit lies in the reduction that
money bonds secure in the unpredictability of consumption that arises from the operation
of real balance effects in an environment of unpredictable money shocks. It is the very
vulnerability of money bonds to inflation makes them useful in immunising the economy
against unpredictable redistributions of purchasing power caused by real balance effects.
Description
Keywords
Real balance effect, indexed bonds, inflation risk
Citation
Source
Type
Working/Technical Paper
Book Title
Entity type
Access Statement
Open Access