INDEXED BONDS, EXPECTED INFLATION, AND TAX CLIENTELE

ment has recently issued inflation-indexed bonds whose yields may be used to provide bond market–based measures of expected inflation. This paper suggests that the U.S. tax treat-ment of the inflation indexation uplift on the principal may create a “tax clientele bias, ” which could cast doubt on the interpretation of the yield gap between indexed and conventional bonds as a market measure of expected inflation. This problem is discussed in the context of the United Kingdom, a country where inflation-indexed bonds have been issued for the past 14 years