for a central bank? over the past decade, policy makers have come to rely on long - term bond yields to measure the public ’ s long - term inflationary expectations. according to some empirical research3, “ almost 80 % of the movement in the long nominal rates appears to be due to changes in expected long - term inflation ”. according to the fisherian theory of interest rates, the long - term nominal interest rate depends upon the ex - ante real interest rate and the expected long - term inflation, factoring in an inflation risk premium. the main problem for the central bank is that, in practice, these three components are unobservable. in this respect, the central bank faces a signal extraction problem, which has important implications in terms of monetary policy decision - making. i will mention three of them. first, aggregate spending decisions are generally viewed as more closely related to long - term [ real ] interest rates. this implies that changes in short - term interest rates, used as the operational target for implementing monetary policy, will only affect aggregate spending decisions if they impact long - term interest rates. under this rationale, the term - structure of interest rates and the relationship between long - term interest rates and long - term expected inflation becomes central to the design of monetary policy. second, inflation expectations may be used by policy makers to gain information about the setting of short - term interest rates, whereas changes in the nominal yield curve, on their own are of no use. an increase in long - term nominal interest rates may be driven by a rise in the long - term expected inflation rate or a rise in the inflation risk premium, but it may also reflect an increase in long - term real interest rates, driven by some real factors. the two first movements could justify a change in the monetary policy stance, once the nature of the underlying shock and its likely duration have been clearly identified, but such a change may be inappropriate in the last case. third, information on long - term inflation expectations can provide monetary authorities with a measure of the credibility of their commitment to price stability. the existence of a market for inflation - indexed securities may provide central banks with very useful information, since it may then enable them to identify whether changes in nominal yields mainly reflect changes in the expected long - term inflation rate or rather whether they are due to changes in real yields. if one assumes, for instance, that both the conventional bond market and the inflation - indexed bond market are efficient and arbit

christian noyer : the role of inflation - indexed bonds in the process of setting monetary policy : a central banker ’ s perspective speech by mr christian noyer, governor of the bank of france, at the morgan stanley seminar on indexed bonds, paris, 9 june 2004. * * * ladies and gentlemen, [ dear friends ], it is a great pleasure for me to address you here in the context of the first “ seminaire de paris ” on inflation - linked securities organised by morgan stanley. today, i will focus more specifically on “ the role of inflation - indexed bonds in the process of setting monetary policy ” from a central banker ’ s perspective, based on my own experience as the former vice - president of the ecb and the current governor of the banque de france. throughout my presentation, i will occasionally refer to the monetary policy strategy framework implemented by the eurosystem in which asset prices, in particular inflation - indexed government bonds, can play a role in the context of our economic analysis. having said this, i will neither elaborate further on the ecb ’ s framework nor comment on the last governing council ’ s monetary policy decision. price indexation of financial contracts is not a new phenomenon. according to robert shiller1, the world ’ s first known inflation - indexed bonds were issued by the commonwealth of massachusetts in 1780 during the revolutionary war. these bonds, the so - called “ depreciation notes ”, were issued to us soldiers as deferred compensation for their services. they were mainly designed to deal with severe wartime inflation. although the bonds were successful, the concept of indexed bonds was set aside until the 20th century. finland introduced indexed bonds in 1945, sweden in 1952, iceland and israel in 1955. since then, indexed bonds have usually appeared in countries experiencing very high rates of inflation, such as brazil in 19642, chile ( 1966 ), colombia ( 1967 ), argentina ( 1972 ) or even the uk in 1975, with the issuance of so - called “ granny bonds ”, i. e. non - marketable indexed - linked savings retirement certificates. later on, in 1981, the uk issued a marketable instrument - the index - linked giltin a context of rapidly increasing prices. in all of these cases, the issuance of inflation - indexed debt instruments by the government was aimed at developing long - term capital markets and improving the credibility of anti - inflationary policies. as regards this last point, such a rationale is, however