Taming Debt: Can GDP-Linked Bonds do the Trick?

Abstract

We study the debt-stabilizing properties of indexing debt to GDP using a consumption-based macro-finance model. Three results stand out: (i) GDP-linked bond prices would embed sizeable and time-varying risk premiums of about 40 basis points, (ii) for a fixed budget surplus, issuing GDP-linked bonds does not necessarily imply more beneficial debt-to-GDP ratios in the medium- to long-run, and (iii) the debt-stabilizing budget surplus is more predictable under such issuances at the expense of being higher on average. Our findings call into question the view that GDP-linked bonds tame debt.