The case for growth-indexed bonds in advanced economies today
Times are changing. The growth indexed bonds were advised by advanced world econs to the developing economies. Now they advise the same for the advanced economies as well. The idea is simple – you get paid as per the growth rate of an economy. If growth goes up, payments to investors rise and vice-versa. Given the volatile and uncertain growth pattern in advanced world, one could look at growth bonds for them as well.
Olivier Blanchard and others have a piece on the same:
One of the legacies of the Global Crisis is a high ratio of public debt to GDP. While current levels may be sustainable, another series of bad shocks could easily tip the balance and lead to unsustainable debt ratios. This column argues that against this background, growth-indexed bonds can help. By decreasing payments when growth is low, they can substantially reduce the upper tail of the distribution of the debt ratio and lessen the risk of a debt explosion.
The economic case for growth-indexed bonds is clear. By indexing interest payments to growth, they limit the increase in the debt ratio in bad times, thus decreasing the probability that the debt becomes unsustainable. As a result, they reduce the default risk premium, further improving the distribution of the debt ratio. However, as interest payments become more volatile, growth-indexed bonds might have to pay a premium in order to compensate investors for the GDP growth risk. If the premium is too high, the benefits of a smaller upper tail may be more than offset by faster increases in the debt ratio under the baseline.
In this column, we explore these issues quantitatively. To anticipate our conclusions, we believe that, today, there is a case for a large issuance of growth-indexed bonds in advanced economies in general, and in the Eurozone members in particular.
Well don’t think any such things can work for EZ. It has much bigger problems and all these bond issuances are just band-aids..