Do sovereign bond spreads in inflation targeting economies reflect creditworthiness and anticipate stress scenarios?

Abstract

When successfully executed, inflation targeting (IT) has managed to prevent situations of fiscal dominance and to anchor inflation expectations. This has helped enhance the information content of the price of government bonds and the perception of sovereign risk, thus adding resiliency to sovereign spreads. The paper assesses the resilience of sovereign spreads of IT economies to shocks and compares with those of countries with other policy frameworks. I conclude that, while in the short term sovereign spreads of IT economies are more resilient to macroeconomic volatilities, they tend to widen in the long run after the shock occurs anyway, independently of the monetary policy framework.