Universität Bonn

Department of Economics

Carolin Pflueger - University of Chicago

“Inflation and Treasury Convenience”, together with Anna Cieslak and Wenhao Li

Abstract

Does high inflation make nominal Treasury bonds less convenient? We show that the correlation between the convenience yield on Treasury bonds and inflation displays low-frequency shifts and has changed sign twice over the past century. The highinflation period of the 1970s and 1980s was associated with a high AAA-Treasury spread, suggesting a greater Treasury bond convenience. By contrast, the low-inflation episodes of the 1920 and pre-pandemic 2000s featured a negative correlation between inflation and the Aaa-Treasury spread, so low inflation was associated with relatively greater Treasury bond convenience. We interpret this evidence through the lens of a New Keynesian model with Treasury bond convenience as in Nagel (2016), and show that the reduced-from shifts in the inflation-convenience relationship line up with the changing dominance of supply vs. demand shocks for inflation. In the model, an equilibrium with cost-push shocks generates the positive inflation-convenience spread correlation of the 1970s and 1980s, as cost-push shocks raise interest rates and, hence, the opportunity cost of holding money increases. An equilibrium with disturbances to the liquidity value of Treasury bonds replicate the negative inflation-convenience spread correlation of the 1920s and 2000s, as a rise in  the private (illiquid) loan rate acts as a negative demand shock and lowers inflation.

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