What is the benefit to the government for issuing inflation-protected securities

[saver7007]

It's easy to see the benefit of inflation protection for holders of TIPS and I Bonds, but what is the benefit to the government and to taxpayers for offering to cover the cost of future inflation? I can't figure it out, it appears one-sided. Also seeing that corporations don't generally issue inflation-indexed bonds makes me suspect they are probably not a great deal for issuers, but there must be some rationale for them.

[retired@50]

Think of the government like a bank trying to draw in customers.

They either have to pay a higher interest rate on your savings, or give away toasters.

If the government wants to borrow more money to continue (what appears to be a long held tradition of) deficit spending, they need to be able to borrow from as many people as possible. So, by offering TIPS and I bonds, they draw in new customers who weren't previously lending their money to the government.

Regards,

[er999]

Think of the government like a bank trying to draw in customers.

They either have to pay a higher interest rate on your savings, or give away toasters.

If the government wants to borrow more money to continue (what appears to be a long held tradition of) deficit spending, they need to be able to borrow from as many people as possible. So, by offering TIPS and I bonds, they draw in new customers who weren't previously lending their money to the government.

Regards,

My understanding is TIPS is a very small portion of the overall US debt so I don't think that's the reason. I am curious myself. For i bonds I think they do it as a service to the small investor but with TIPS there's no dollar limit so that isn't the explanation for why they issue TIPS.

[JoMoney]

I do think it's an interesting question to consider. I'm also interested in others speculations as to why, or if there are any definitive explanations made when they started. Perhaps it is of benefit to them that savers which might be concerned about inflation, have an option to do their saving in a dollar-denominated security rather than being drawn to holding precious metals, commodities, foreign currency, or something else outside the monetary system.

[StrangePenguin]

Think of the government like a bank trying to draw in customers.

They either have to pay a higher interest rate on your savings, or give away toasters.

If the government wants to borrow more money to continue (what appears to be a long held tradition of) deficit spending, they need to be able to borrow from as many people as possible. So, by offering TIPS and I bonds, they draw in new customers who weren't previously lending their money to the government.

Regards,

My understanding is TIPS is a very small portion of the overall US debt so I don't think that's the reason. I am curious myself. For i bonds I think they do it as a service to the small investor but with TIPS there's no dollar limit so that isn't the explanation for why they issue TIPS.

TreasuryDirect says that TIPS were created "after the market expressed a strong interest" https://www.treasurydirect.gov/research ... ties/tips/. I agree with retired@50 -- the market asked for it and the Treasury wants people to buy their debt, so they offered the product.

[exodusNH]

I do think it's an interesting question to consider. I'm also interested in others speculations as to why, or if there are any definitive explanations made when they started. Perhaps it is of benefit to them that savers which might be concerned about inflation, have an option to do their saving in a dollar-denominated security rather than being drawn to holding precious metals, commodities, foreign currency, or something else outside the monetary system.

But it can also benefit the government. The market prices TIPS and nominals in a way that ensures a roughly equal return if inflation meets the market's expectations. If inflation winds up lower than the market expected, the government makes out. If it matches it, the government comes even. If inflation is higher, then the TIPS holders made out.

Many of the entities that hold the longer-dated bonds do so because they have nominal expenses. E.g., life insurance, non-indexed pensions, loan offsets. They don't need inflation protection, which has to come at some cost, since it reduces a risk.

TIPS were introduced during a period of stable and low inflation. That probably lowered the demand somewhat. We'll see how the market evolves over the next few years. Canada recently stopped issuing inflation-linked bonds.

If the US were to stop, it might be seen as a sign that we don't expect to get it under control.

[halfnine]

I do think it's an interesting question to consider. I'm also interested in others speculations as to why, or if there are any definitive explanations made when they started. Perhaps it is of benefit to them that savers which might be concerned about inflation, have an option to do their saving in a dollar-denominated security rather than being drawn to holding precious metals, commodities, foreign currency, or something else outside the monetary system.

This is my guess as well. To keep those seeking an asset with inflation protection within the country's monetary system.

[SB1234]

Least I heard the government was for the people.

[RubyTuesday]

Additionally to the reasons supposed above, selling TIPS provides a useful market estimate of future inflation.

[WilliamOfOckham]

Maybe because they get their cut regardless?
"Federal tax due each year on interest earned. Any increase or decrease in the principal during the year may affect your federal taxes."
https://www.treasurydirect.gov/marketab ... ties/tips/

I bonds too.

[exodusing]

Real inflation is likely twice as high as tips and ibonds pay out so not too bad of a deal for government after all.

This. They can manipulate the inflation number.

Twice as high? Manipulation? Is there published research on this? I could believe that there might be a timing difference in the reported figure/adjusted figure, but twice as high seems hyperbolic.

Why do you think core inflation was invented?

It was invented because some components of inflation are very volatile, so CPI numbers would bounce around a lot, obscuring the trend. Core inflation essentially smooths out the reported numbers. If you look at core and CPI over time, they end up being about the same, it's only in the short term they diverge.

[aristotelian]

The expected cost to the government is the same as with nominal bonds, just as the expected return to the consumer is the same. They each protect against different risks and are exposed to different risks. I would say the benefit to both is the ability to finance debt as well as debt-diversification in case inflation is higher or lower than expectations.

[dumbmoney]

It's not "one sided" because like any bond it's priced (mainly) on expected return. So ignoring fine details, it doesn't change the expected cost of servicing the debt.

They exist because the idea appealed to academic economists, Wall Street always likes to have more stuff to trade, and some investors like them.

[JoMoney]

Since the Postal Service Retirement fund, and I believe other federal pension plans, are restricted to using U.S. Treasury Securities, and provide inflation indexed benefits, probably helpful to managing the risks of inflation to those plan benefits.

[toddthebod]

In an environment where bond yields had fallen from the teens to 6-7% over the previous 15 years, it's not unreasonable to think the government was looking for a way to get more people to invest in Treasury bonds, and news from the time backs up that they thought they could sell more bonds and overall it would be cheaper:

From the LA Times in 1996:

In financial markets, you rarely get something for nothing. If the Treasury is going to lower the inflation risk of holding a bond, that bond is likely to pay less interest upfront than regular Treasury bonds.

In other words, if a regular 10-year Treasury note pays an annual yield of 6.7%, an inflation-adjusted 10-year note might pay about half that yield, because of the inflation-protection feature.

Exactly how much the yields will differ isn't clear, because the Treasury isn't sure how it will structure the new bonds. But in any case, the Treasury has made it clear that one goal in issuing the new bonds is to reduce the government's financing costs.

Chicago Sun-Times, 1996:

The Treasury Department said Thursday it will issue inflation-protected bonds that will provide an attractive way for middle-income investors to save for retirement.

Treasury Secretary Robert Rubin said the new bonds would have "the potential of raising our national saving rate as well as reducing the cost of capital to the federal government."

Rubin said he thought the bonds would be attractive to people saving for their retirement, their children's college education or other long-term purposes.

And finally the NYT:

In an effort to get Americans to save more, the Treasury announced plans today to issue a new type of Government bond that would protect average investors from inflation as well as help the Government finance the national debt.

The new bonds would offer returns that would rise and fall in line with inflation -- a feature that the Treasury said should make Americans more willing to buy Government bonds to pay for their retirement or their children's education. The bonds would be backed by the Government and priced so that unexpected increases in inflation would not erode their value.

''We will be offering a unique investment vehicle, an opportunity for middle-income people to save for retirement or their kid's education,'' said Treasury Secretary Robert E. Rubin. ''We are trying to better serve citizens by creating a vehicle that provides inflation protection, a real rate of return and the backing of the Government. Over time, this will be well used by Americans seeking to save.''

Mr. Rubin said the bonds would not be issued until later this year, at the earliest, and that many decisions still had to be made: How many bonds to sell, what inflation index to use in setting the prices for the bonds, whether to sell 10-year or 30-year bonds, or both. He said the Treasury would soon meet with Wall Street executives, mutual fund companies and average investors to sort out these issues.

However these issues are decided, Mr. Rubin said, the new bonds are expected to help cut the cost of borrowing and enable the Government to turn to the growing retirement market to help finance the national debt. Currently, a total of $675 billion is invested in 401(k) plans, or self-directed retirement plans, according to Access Research of Windsor, Conn., and these bonds are expected to be marketed as a new option in such plans.

Right now, Government bonds are not a popular option for 401(k) plans and other forms of long-term savings. Government bonds generally offer lower returns than stocks or corporate bonds. And while these other investments may be riskier than Government bonds, their higher returns have been a way that average Americans have tried to protect their savings from inflation.

''This new security is a good idea that makes great sense,'' said Allen Sinai, chief global economist at Lehman Brothers, an investment banking firm. ''If the inflation index goes up, so do their returns. This makes these bonds safer for investors than bonds without this protection. I would expect this to turn out to be a very popular item.''

These inflation-indexed bonds are also expected to be a popular item for the many brokerage and money market firms that package 401(k) plans and college savings plans. ''It's an excellent idea,'' said Paul Boltz, chief economist at T. Rowe Price, a Baltimore mutual fund company. ''We always tell investors that they have to take inflation into account in their long-term savings. This is one way for them to have it covered.''

The Treasury is proposing that these bonds be sold in denominations as low as $1,000. Mutual fund companies and brokerage firms, however, may decide to buy some of these bonds in bulk and repackage them in even smaller amounts for their customers.

The Treasury is still trying to decide how to structure the bonds. In its simplest form, the principal value of a $1,000 bond would rise to $1,030 at the end of the year if inflation is 3 percent that year. If inflation is lower, the figure could be lower; if inflation is higher, the number could be higher. In addition, the coupon -- the interest paid every six months on such bonds -- would rise in line with the inflation index being used.

The Treasury is also considering other options for these bonds: One would be a zero-coupon bond, in which a person gets all his money back at the end of the bond's life along with an inflation premium. Other possible types of bonds would pay interest and some principal each year.

The bonds are a departure from the Treasury's reliance on issuing only fixed-rate securities -- ones with a set interest rate that does not change over time. The Treasury estimates that it can cut its own borrowing costs and save taxpayer money with these bonds because they will, in general, be issued for lower rates than comparable fixed-rate securities because they offer this inflation protection.

''We hope to save money for the taxpayers with these bonds,'' said Darcy E. Bradbury, the Treasury's Assistant Secretary for Financial Markets.

But if inflation rises, the bonds could prove to be much more expensive for the Government over their lives than conventional bonds.

Currently, Britain and Canada are the largest issuers of such bonds. In Britain, such inflation-indexed bonds represent about 15 percent of the Government bond market. Money managers said similar securities had also been issued in Australia, New Zealand and Sweden.

Treasury officials said they hoped the proposed new bonds would encourage people to save more. ''Most economic experts believe that a higher savings rate is good for the economy,'' said Lawrence H. Summers, the Deputy Treasury Secretary. ''It permits more investments in America, so that is good for the nation. And since people are living a longer time, people have more need to put money aside. At other times, inflation has had a very pernicious effect on savings.''

While many in the bond markets and Wall Street expressed interest in these bonds, there were some concerns. Some bond dealers were questioned why the Government was issuing inflation-protected bonds at a time when inflation was low. Others wanted to make sure that the Government would issue bonds in sufficient numbers to create a broad and robust market for traders.

''The timing of these bonds is somewhat difficult to understand,'' said David M. Jones, vice chairman of Aubrey G. Lanston & Company, a New York government securities dealer. ''It is a period of time when inflation, thank goodness, is not a major problem. So the question of how attractive these will be to individual investors is up in the air.''

Mr. Jones was also concerned that the issuance of the bonds might be a signal to foreign investors that the United States was having trouble keeping inflation under control. ''Typically, these bonds were started in countries where inflation was a problem,'' Mr. Jones said.

And Ian MacKinnon, head of the fixed-income division at the Vanguard Group, a Valley Forge, Pa., mutual fund company, warned that while investors could do well in periods of high inflation, they could be disappointed with returns in deflationary times. If inflation is negative -- that is, if consumer prices are falling over a sustained period -- investors may see the coupon payments and the principal value of their inflation-indexed bonds decline.

''This is a good idea with certain caveats,'' Mr. MacKinnon said. ''It won't be a perfect hedge against inflation, although it will go a long way in that direction. But, there is still no guarantee that you will have more wealth at the end than if you bought a fixed-income bond. It might be the opposite. If you had deflation, you'd be better off in a fixed-income bond than in an inflation-index bond. It's kind of a mixed bag.''

Graph
''America's Dwindling Savings Rate'' shows personal saving as a percentage of disposable income from 1980 to 1996. (Source: Datastream)(pg. D4)

Word count: 1265
Copyright New York Times Company May 17, 1996

[JoMoney]

...
This all originates in something call the Boskin Commission in the 1990s. A group of conservative politicians and economists argued the US was systematically overstating inflation, and thus indexing benefits like Social Security too high. It all has to do with hedonics - how you account for quality changes in what you buy. There's almost no comparison between a 1990 car and a new one now in terms of horsepower, acceleration, safety equipment and standard comfort features, for example. Let alone a laptop computer (remember the old "luggables"?) from Compaq (then) v one from Acer (now). Consider you carphone (as we still called them) in 1990 v your smartphone now.

What was your broadband bill in 1990? And what speed of internet connection did you receive for that? How much did your LED screen tv cost then? What about the proton beam therapy for your child's cancer? That airbag which saved your spouse's neck when that idiot him them head on? How much did that cost in a car in 1986?

You would not want to be treated for leukaemia in 1985 vs now. You really would not. The Covid pandemic in 1980 would have killed several times as many people - because we just didn't have the gene mapping technology that we used to create a vaccine. The average time to a vaccine for a novel virus was something over 10 years, as little as 20 years ago. As opposed to less than 12 months.

As a result of this the BLS started to include hedonic changes.

What is true is that your personal rate of inflation can be very different from CPI-U. In particular prices of services (like healthcare) have risen whilst prices of goods (flat screen tvs) have fallen...

They can argue that, but food, housing, and energy costs are much larger and universal concerns than the quality of their TV.
An "average" U.S. salary could support a family decades past, while today a dual-income family can't afford the child care to allow a couple to work... while they watch the decline in the education system available to their children.

[nisiprius]

...From the LA Times in 1996:...

Great stuff, go read.

What it doesn't say, but I... you know... "I'm almost sure I read it someplace!"... is that part of the motivation was that they wanted to create a prediction market for inflation. I haven't heard much about "prediction markets" lately, but a decade or so there was almost a faddish interest in setting up "prediction markets" that were basically gambling parlors where people could place actual money bets on financial predictions. The idea was that these "markets" could harness the wisdom of crowds and predict things that individuals couldn't.

[SteadyOne]

Another reason might be that they have to show that there are government bond investments that benefit ordinary people. Those who just want safe instruments to save safe from inflation. This is how IBonds came to be as well

[MOBY DICK]

TIPS are one of those things that sound good to have. Actually seemed like a no-brainer.
They have proven to be worse than useless after real inflation kicked in 2 years ago.
So apparently it did work well... for the government... not for the investor.
So much for all the TIPS discussions.

[nisiprius]

I can say categorically that Shadowstats is garbage. In short:

• they aren't telling exactly what they do;
• they aren't doing what they say;
• if they are doing what they seem to be doing--calculating the effect of a constant underestimate--they are doing it wrong.

They are not recalculating CPI according to pre-1980s methods. They just took some guesstimate of the annual percentage by which they think the CPI understates inflation. Their "1980s method" numbers seem to be the actual CPI number, increased by a constant amount, equal to that underestimate, every year.

You can tell by eyeball that they are not using the 1980 method, because if they were using actual housing prices instead of owner equivalent rent, you would see a notch or dip in Shadowstats when the housing bubble burst, that should be much less in the CPI calculated using owner equivalent rent--and you don't.

They almost certainly bungled the math by getting confused between annual inflation, and CPI, which is the cumulative effect of annual inflation. Instead of adding a constant adjustment for underestimate to the annual CPI rate, which would cause a cumulative error in the index, they added an additional amount to the rate every year.

The BLS methodology is documented and transparent. The Shadowstats methodology is secret. The Shadowstats site author promised to submit his data and methodology to "an academic" for review, and publish the results, and never has.

During the time when the data from the MIT Billion Prices program was available for free, you could see that CPI was in reasonable agreement with their independent estimate, derived from screen-scraping prices off the Internet.

The Bureau of Labor Statistics doesn't have calculations of current inflation based on the old methods, but they have published something the other way around--what past inflation would have been if recalculated by current methods.

[longinvest]

After issuing its first Real Return Bond (RRB) more than 31 years ago, the Canadian government has recently lost its appetite for inflation indexed bonds in November 2022, just before the usual December 1st issue date:

Fall Economic Statement - 2022

Real Return Bond Program
The government has decided to cease issuance of Real Return Bonds (RRBs) effective immediately. This decision reflects low demand for this product and will allow the government to promote liquidity by consolidating funding within our core funding sectors.

A few years ago, both U.S. and Canadian insurance companies stopped issuing life annuities (SPIAs) indexed to the consumer price index (CPI or CPI-U).

The interesting questions for investors are:

• Why don't other borrowers than governments, such as corporations, issue inflation-indexed bonds?
• Would you personally borrow with interest payments and borrowed capital indexed to inflation?

If inflation-indexed borrowing isn't attractive for corporations and individuals, why should it be attractive for governments?

[longinvest]

The (gradual) disappearance of an entire asset class (inflation-indexed bonds) in Canada poses an interesting problem for investors with a fixed allocation policy, like 50% of bonds into inflation-indexed bonds. This policy won't be sustainable as existing bonds mature.

There's a lot of discussion in this forum about the specific behavior of various assets. Yet there seems to be less attention given to the crucial importance of their market capitalization. I think that there are benefits to paying attention to the relative (free float) market capitalization of assets when designing one's portfolio. Isn't this, actually, the fundamental principle of indexing?

[ModifiedDuration]

Another reason might be that they have to show that there are government bond investments that benefit ordinary people. Those who just want safe instruments to save safe from inflation. This is how IBonds came to be as well

+1

[alluringreality]

If inflation-indexed borrowing isn't attractive for corporations and individuals, why should it be attractive for governments?

I'm not sure that individuals, corporations, and governments necessarily share similar considerations. Basically I tend to think along the lines of David Swensen's position given in Unconventional Success. It seems reasonable enough to me that the justification upthread about "reducing the cost of capital to the federal government" might be one reason to consider inflation-indexed borrowing attractive. Of course it would probably make sense to consider revisiting that position when there's a big jump in financing cost, such as exhibited by how much TIPS payments have jumped relative to their portion of outstanding debt. I'd suspect that Canada likely saw a similar recent jump in financing cost for inflation-indexed debt.

[rich126]

Real inflation is likely twice as high as tips and ibonds pay out so not too bad of a deal for government after all.

This. They can manipulate the inflation number.

Twice as high? Manipulation? Is there published research on this? I could believe that there might be a timing difference in the reported figure/adjusted figure, but twice as high seems hyperbolic.

The "Shadow Stats" websites has published inflation data using the same methodology as was used in prior years that can be compared to the government data that has changed methodologies.

The ShadowStats site has been shown to contain false data and calculations by a number of economic/science researchers. I wouldn't trust their info at all. In one case they took one error rate and miscorrectly used it as an annual rate instead of a cumulative rate which made most of their numbers horrible inaccurate.

Since this is getting off topic, this will be my only comment on that data.

[exodusing]

They can argue that, but food, housing, and energy costs are much larger and universal concerns than the quality of their TV.
An "average" U.S. salary could support a family decades past, while today a dual-income family can't afford the child care to allow a couple to work... while they watch the decline in the education system available to their children.

The share of national income going to labor had declined over decades past. That has likely had a larger effect than inflation. If labor had more bargaining power, it would have been able to keep its share steady, whatever inflation might have done.

[arcticpineapplecorp.]

Another reason might be that they have to show that there are government bond investments that benefit ordinary people. Those who just want safe instruments to save safe from inflation. This is how IBonds came to be as well

+1

another reason might be as the Jeff Wrase, senior economist in the Research Department of the Philadelphia Fed put it in in the following paper from July/Aug 1997 and reprinted below at the St. Louis Federal Reserve: :

In a Newsweek article in 1971, economist and Nobel Laureate Milton Friedman scolded the government for repaying its debt in dollars
whose value is eroded by inflation. His prescription was to:

“Let the Treasury promise to pay not $1,000 but a sum that will have the same purchasing power as $1,000 had when the security was issued. Let it pay as interest each year not a fixed number of dollars but that number adjusted for any rise in prices.”

Now, 26 years after the urging of Professor Friedman and a host of commentators before and after him, the U.S. Treasury has unveiled
an “inflation-protection security.”

source: https://fraser.stlouisfed.org/files/doc ... 199707.pdf

[Walkure]

I think a big part of the reason they offer them, despite being a small subset of the treasury market, is to get a "wisdom of the crowd" number for expected inflation. Because the real "risk free rate" is non-stationary, it's impossible to perfectly determine inflation expectations from nominal bonds alone. By comparing TIPs of the like duration, they can get a spread that accurately reflects the expectations of the market throughout the term structure. This has all sorts of useful applications for setting monetary and fiscal policy.

[ScubaHogg]

If inflation-indexed borrowing isn't attractive for corporations and individuals, why should it be attractive for governments?

Because the risk is radically different for the people who print the money…?

[nisiprius]

Money illusion is powerful. It's said that there was lack of demand for CPI-indexed SPIAs, and I must assume that it's true. When there have been discussions in the forum, people have exhibited sticker shock at the high premium for an inflation-indexed annuity. People seem interested when they vaguely suppose it's a little rider that you can get almost for free, and shocked when they find that it costs, ballpark 30% more for the same starting payout. Hersh Stern, owner of the immediateannuities website, dissed them in an interview as being "too" expensive.

But that's the point! An inflation-adjusted annuity is statistically likely to pay out a lot more over the annuitants' life, not just a little more. And the prices for inflation-linked SPIAs were in line with the prices for annuities that have a fixed 3%-compounded annual payout increase.

[longinvest]

If inflation-indexed borrowing isn't attractive for corporations and individuals, why should it be attractive for governments?

Because the risk is radically different for the people who print the money…?

I don't understand. If I was a government and I was able to print money, nominal bonds would be far more attractive for me as they would allow me to easily inflate away my debt by printing additional money.

Can you further explain your thoughts?

[alluringreality]

Can you further explain your thoughts?

Essentially government policy is likely to have more influence on inflation than choices by an individual or corporation, so unexpected inflation risk probably does not equally affect those three entities. Your own line of thought seems to run in a similar direction, although potentially for different reasons.

[MarkRoulo]

The (gradual) disappearance of an entire asset class (inflation-indexed bonds) in Canada poses an interesting problem for investors with a fixed allocation policy, like 50% of bonds into inflation-indexed bonds. This policy won't be sustainable as existing bonds mature.

There's a lot of discussion in this forum about the specific behavior of various assets. Yet there seems to be less attention given to the crucial importance of their market capitalization. I think that there are benefits to paying attention to the relative (free float) market capitalization of assets when designing one's portfolio. Isn't this, actually, the fundamental principle of indexing?

If you expect to trade the assets (because re-balancing or to maintain a given duration or for some other reason) then the size of the free float market can matter. Though for small individual investors this is less of a concern than for large institutional investors.

If you expect to buy and hold until maturity then free-float matters less because you won't be trading.

My wife purchased TIPS around 2000 for her IRA. The bonds themselves rather than a TIPS fund. With no intention of selling them any time soon it didn't matter too much what the free float was. And it wasn't like she needed to purchase a lot of them from various lenders to hedge default risk.

I'd take into account free float for stocks (and for VERY small stocks it might be an issue even for individuals) or thinly traded ETFs (e.g. the NGE ETF) or individual bonds that I intended to sell rather than hold until maturity.

[And, no, paying attention to free-float is not THE fundamental principle of indexing I'm not sure that there IS a single fundamental principle for indexing.]

[wolf359]

Least I heard the government was for the people.

As in, "I'm from the government, and I'm here to help"?

[NiceUnparticularMan]

I think it is mostly a low-to-no cost public service.

The pricing on TIPS and Treasuries has ended up very similar (anecdotally I think at least some people were expecting more premium to TIPS, but not so far). Maybe there is a slight volume increase at the same price. But overall, I doubt the US government is getting a substantial financial benefit from TIPS, but nor is it experiencing a substantial cost.

[MarkRoulo]

Real inflation is likely twice as high as tips and ibonds pay out so not too bad of a deal for government after all.

This. They can manipulate the inflation number.

Twice as high? Manipulation? Is there published research on this? I could believe that there might be a timing difference in the reported figure/adjusted figure, but twice as high seems hyperbolic.

The "Shadow Stats" websites has published inflation data using the same methodology as was used in prior years that can be compared to the government data that has changed methodologies.

If you look at this chart from the shadowstats site:


You can see that the chart shows "real" inflation from about year 2000 to the present (so about 23 years) to be averaging around 10% per year.

10%/year inflation over 23 years works out to a bit over an 8x increase in prices over the same 23 years.

If someone wants to believe this chart then they pretty much need to believe that $10,000 in 2000 purchased the same standard of living that $80,000 does today. Because math.

I don't believe that.

The official inflation stats show about 1.8x (lets round it to 2x) inflation from 2000 to today, so $40,000 - $45,000 in 2000 would be equivalent to $80,000 today. I find the ~2x to match what I see much more closely than 8x.

[ScubaHogg]

If inflation-indexed borrowing isn't attractive for corporations and individuals, why should it be attractive for governments?

Because the risk is radically different for the people who print the money…?

I don't understand. If I was a government and I was able to print money, nominal bonds would be far more attractive for me as they would allow me to easily inflate away my debt by printing additional money.

Can you further explain your thoughts?

Mainly I was saying that just because it’s too risky and unattractive for corporations and individuals, that wouldn’t be disqualifying for a government because the risks are so radically different

But if u need some reasons for the government to do it:

- useful prediction market
- I’m no Pollyanna for governments, but even I recognize it is somewhat responsive to demands by the public. So simple providing a product that the populous wants
- Govt is serious about lowering inflation. If inflation is lower than expected TIPS are a cheaper form of govt financing
- if it gives credibility to stated inflation targets, providing TIPS might lower the govt cost of financing in both tips AND nominals

[km91]

If you look at this chart from the shadowstats site:


You can see that the chart shows "real" inflation from about year 2000 to the present (so about 23 years) to be averaging around 10% per year.

10%/year inflation over 23 years works out to a bit over an 8x increase in prices over the same 23 years.

If someone wants to believe this chart then they pretty much need to believe that $10,000 in 2000 purchased the same standard of living that $80,000 does today. Because math.

I don't believe that.

The official inflation stats show about 1.8x (lets round it to 2x) inflation from 2000 to today, so $40,000 - $45,000 in 2000 would be equivalent to $80,000 today. I find the ~2x to match what I see much more closely than 8x.

ShadowStats is garbage and the data is fake. Apply their "true" inflation rate to nominal GDP growth officially reported by BEA and it turns out the US economy actually shrunk in real terms by 25% in the last 20 years. The US economy is producing 1/4 less goods and services than it was in 2000? Give me a break, their data doesn't stand up to even the slightest bit of scrutiny or logic

[er999]

Tips definitely push out the cost to the government until later. Take, say a 30 year tips compared to a nominal. Much of the return with a tips comes from the 30 year inflation adjusted return of principal where a nominal 30 year return of principal is much lower. So perhaps with tips pushing out the cost to later so is attractive to the government. Same rational like why allow Roth IRAs — they get more money in tax now even though less later.

[Angst]

+1 to all the posts quoted below.

When I saw this thread topic, my thoughts immediately went to the singular usefulness of all the data that a real rate marketplace provides for economists and investors.

Additionally to the reasons supposed above, selling TIPS provides a useful market estimate of future inflation.

The expected cost to the government is the same as with nominal bonds, just as the expected return to the consumer is the same. They each protect against different risks and are exposed to different risks. I would say the benefit to both is the ability to finance debt as well as debt-diversification in case inflation is higher or lower than expectations.

[SNIP]... part of the motivation was that they wanted to create a prediction market for inflation. I haven't heard much about "prediction markets" lately, but a decade or so there was almost a faddish interest in setting up "prediction markets" that were basically gambling parlors where people could place actual money bets on financial predictions. The idea was that these "markets" could harness the wisdom of crowds and predict things that individuals couldn't.

I think it is mostly a low-to-no cost public service.

The pricing on TIPS and Treasuries has ended up very similar (anecdotally I think at least some people were expecting more premium to TIPS, but not so far). Maybe there is a slight volume increase at the same price. But overall, I doubt the US government is getting a substantial financial benefit from TIPS, but nor is it experiencing a substantial cost.

[randomguy]

It's easy to see the benefit of inflation protection for holders of TIPS and I Bonds, but what is the benefit to the government and to taxpayers for offering to cover the cost of future inflation? I can't figure it out, it appears one-sided. Also seeing that corporations don't generally issue inflation-indexed bonds makes me suspect they are probably not a great deal for issuers, but there must be some rationale for them.

Imagine it is 1981. Which is better for the government
a) Issuing a 14% nominal bond
b) Issuing a 2% real bond with 12% inflation adjustment

In case a, they paid out 14% for 20 years. In case B they paid out 14%, then 10%, then 8%, and then 6% as inflation dropped over the years

Right now a 10 year TIPS at like 1.2% or a nominal 3.5%. You are placing a bet on what inflation will be over the next 10 years. If it averages 1%, you want the nominal. 3%? go with the tips. You can argue the risk is pretty asymmetrical (i.e inflation going to 20% is possible, tips are protected against deflation if you hold them) at current rates.

Corporations tend to like fixed things because they are easier to plan around. They can't print money like the government.

[Geologist]

In looking over the news stories at the time of origin of TIPS, it is sort of touching to see the quotations about TIPS for “middle-income investors”. I say that because the Treasury market is overwhelmingly an institutional market and TIPS today are exactly like that.

The latest 5-year (4 year, 10 month actually) and 10-year TIPS auctions had 99% of their notes going to competitive bidders (i.e., institutions). That was $36 billion. The total assets [all classes] of the Vanguard Inflation-Protected Securities Fund and Vanguard Short-term Inflation-Protected Index Fund are only $80 billion, so I would suggest most of these purchases are not going into retail mutual funds (that is, individual investors but indirectly). The main investors are institutions that have their own rationale.

[exodusNH]

In looking over the news stories at the time of origin of TIPS, it is sort of touching to see the quotations about TIPS for “middle-income investors”. I say that because the Treasury market is overwhelmingly an institutional market and TIPS today are exactly like that.

The latest 5-year (4 year, 10 month actually) and 10-year TIPS auctions had 99% of their notes going to competitive bidders (i.e., institutions). That was $36 billion. The total assets [all classes] of the Vanguard Inflation-Protected Securities Fund and Vanguard Short-term Inflation-Protected Index Fund are only $80 billion, so I would suggest most of these purchases are not going into retail mutual funds (that is, individual investors but indirectly). The main investors are institutions that have their own rationale.

Does this count TIPS bought on the secondary market? My uneducated guess is that most people probably don't buy new issues simply because the Treasury's auction schedule doesn't match an individual's need to purchase.

It probably also misses those owned via MFs/ETFs.

If I understand correctly, the institutional investors are obligated to participate in the auctions or lose their rights to do so.

[Geologist]

In looking over the news stories at the time of origin of TIPS, it is sort of touching to see the quotations about TIPS for “middle-income investors”. I say that because the Treasury market is overwhelmingly an institutional market and TIPS today are exactly like that.

The latest 5-year (4 year, 10 month actually) and 10-year TIPS auctions had 99% of their notes going to competitive bidders (i.e., institutions). That was $36 billion. The total assets [all classes] of the Vanguard Inflation-Protected Securities Fund and Vanguard Short-term Inflation-Protected Index Fund are only $80 billion, so I would suggest most of these purchases are not going into retail mutual funds (that is, individual investors but indirectly). The main investors are institutions that have their own rationale.

Does this count TIPS bought on the secondary market? My uneducated guess is that most people probably don't buy new issues simply because the Treasury's auction schedule doesn't match an individual's need to purchase.

It probably also misses those owned via MFs/ETFs.

If I understand correctly, the institutional investors are obligated to participate in the auctions or lose their rights to do so.

It has nothing to do with secondary markets, but the standard Treasury block on secondary markets is $1 million (according to Annette Thau in her authoritative The Bond Book) and individuals don't make trades that big. Individuals are just not significant players in the Treasury markets.

I pointed out that two auctions are half the size of Vanguard's Mutual Fund/ETF total assets (and Vanguard is a big player in this space)...this suggests that Mutual Funds/ETF's can only be limited players.

There are only about two dozen primary Treasury dealers. There are a lot more institutional investors than that.

[secondopinion]

TIPS are one of those things that sound good to have. Actually seemed like a no-brainer.
They have proven to be worse than useless after real inflation kicked in 2 years ago.
So apparently it did work well... for the government... not for the investor.
So much for all the TIPS discussions.

Did they fail? The government had to pay more interest. TIPS “failed” only because the market real yield increased. That is a big difference from being good for the government.

[MathWizard]

I bought iBonds to get the 9.62% rate for 6 months
the 9.62% was based on a fixed rate of inflation and 9.62% inflation rate.

Having a little bit of my cash tied to inflation is something useful to me, so I will
accept a real return of 0 on that portion.

For the Feds, there are plenty of areas where the interest is not tied to
inflation that they will be paying back with cheaper dollars. It helps cash flow to
"borrow" money from me at 0% real (or 0.40% real for current iBonds).

[Ocean77]

A big debtor generally benefits from inflation. Maybe somebody had the foresight to change that equation and at least reduce the incentive somewhat to drive inflation up.

[alluringreality]

Here is a press release item from 1997. Aside from the recent period, generally TIPS have ended up paying less than nominals historically. It remains to be seen what happens going forward, but here is one taxpayer justification.

How Treasury Has Benefited
As an issuer of the securities, Treasury is also happy with the program. We have established a program that, over the years, will cost the government and the taxpayers less than nominal debt. This will result from the government, instead of investors, taking the risk of inflation. In brief, we will receive the inflation risk premium instead of paying it. And we can bear the risk of inflation more efficiently than can any single investor, no matter how large.

https://home.treasury.gov/news/press-releases/rr1966

[WilliamOfOckham]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

[alluringreality]

My point earlier was that none of these products actually keep up with inflation. They collect tax on inflation. A win-win for Uncle Sam.

I'm not sure this is necessarily accurate for TIPS held in a tax-advantaged account. Of course tax will typically be paid at some point, but in terms of the payment not corresponding with the methodology, I cannot say that I'm following the suggestion for all considerations.
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