The Procyclicality of Inflation-Linked Debt

Abstract

This paper uses UK time-series data to document that the ratio of inflation-linked debt to total public debt (“linker share”) is procyclical. The business cycle properties of the linker share indicate a positive relationship with inflation, even after controlling for breakeven inflation. This can be explained by the tax-smoothing incentives of the government in a simple Ramsey model. Results are similar for the US.

Keywords: Government Debt, Optimal Fiscal Policy, Inflation-Indexed Bonds JEL codes: E31, E62, G11