Economic Letter: The rationale for GDP-linked bonds for the euro area

An Economic Letter by Lorenz Emter and Valerie Herzberg considers how performance related government bonds, such as GDP-linked bonds, can play a role in enhancing the architecture of the  Economic and Monetary Union, improving risk management in the absence of more fiscal integration.

The key findings are:

• With payments linked to economic outcomes, GDP-linked government bonds could assist Member States to simultaneously reduce and share risks. In economic downturns, the issuer would pay less and the holder of the security would receive less, while in periods of economic upswing, the opposite would occur.
• These instruments have additional benefits for highly open economies, such as Ireland. In countries where government revenues are highly volatile such methods of sharing risk with non-residents could prove useful.
• However, in order for countries to avail of this opportunity of risk sharing, the additional cost of issuing this government debt needs to be contained. Were larger Member States to lead the vanguard in introducing these new instruments, they would reduce novelty and liquidity premia. Any stigma around these bonds would be overcome and smaller Member States could then follow.

The views presented in Economic Letters are those of the authors and do not necessarily represent the official views of the Central Bank of Ireland.

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