The spread of inflation-indexed bonds serves as a historical precedent. Finland was the first to issue national inflation-indexed bonds, in 1946, in response to massive wartime price growth. Israel and Iceland were next, in 1955, followed by Brazil, Chile, Columbia, Argentina, the UK, Australia, Mexico, Canada, Sweden, New Zealand, the US, France, Japan and Italy. It took a long time, but the contagion of a sound financial idea has been unmistakable. GDP-linked bonds would also allow hedging the risk of inflation, plus respond to GDP growth.
Some will object that there is little point in creating GDP-linked bonds in advanced countries, because there is little uncertainty about GDP growth there. However, even in the relative calm of the post-war era, long-term real GDP growth in advanced countries has been rather variable.
For example, US real per capita GDP grew by a factor of 1.87 -- that is, nearly doubled in size -- from 1961 to 1986, but by a factor of only 1.58 from 1978 to 2003. Such differences in 25-year growth rates are important: if US GDP grows by a factor of 1.87 over the next 25 years, annual GDP will be US$3.6 trillion (US$10,000 per person) higher than if it grows by a factor of only 1.58.
Much of today's debates about the future of old-age pensions hinges on this uncertainty. If the economy grows rapidly, there will be no problem; if it does not, a pension crisis looms. Creating a marketplace where such uncertainties are traded and hedged would be a fundamental step toward managing the risks involved.
If personal pension accounts or provident funds are invested in GDP-linked bonds, the payments that retirees receive in 25 years will reflect the growth rate of the economy -- and that of the tax base -- to that date, which all makes good sense. Sweden's pension system recently created a link between national income growth and benefits, but the reforms did not include creating GDP-linked bonds, a natural adjunct to such a scheme.
At a time when many advanced countries run government deficits, GDP-linked bonds would improve risk management and bring down financing costs. They might also spur developing countries to do what it takes to join that market.
Robert Shiller is a professor of economics at Yale University, and author of Irrational Exuberance and The New Financial Order: Risk in the 21st Century.
Copyright: Project Syndicate
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