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Treasury inflation-indexed debt: a review of the U.S. experience

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  • Brian Sack
  • Robert Elsasser
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    Abstract

    This article describes the evolution of Treasury inflation-indexed debt securities (TIIS) since their introduction in 1997. Over most of this period, TIIS yields have been surprisingly high relative to those on comparable nominal Treasury securities, with the spread between the nominal and indexed yields falling well below survey measures of long-run inflation expectations. The authors argue that the low relative valuation of TIIS may have reflected investor difficulty adjusting to a new asset class, supply trends, and the lower liquidity of indexed debt. In addition, investors may have had a benign outlook for inflation and may not have demanded much, if any, of an inflation risk premium to hold nominal securities. As a result, inflation-indexed debt has not yet lived up to one of its main purposes: to reduce the Treasury's expected financing costs. More recently, though, TIIS market liquidity and the breadth of investor participation have increased considerably, and the valuation of these securities appears to have improved.

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    Bibliographic Info

    Article provided by Federal Reserve Bank of New York in its journal Economic Policy Review.

    Volume (Year): (2004)
    Issue (Month): May ()
    Pages: 47-63

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    Handle: RePEc:fip:fednep:y:2004:i:may:p:47-63:n:v.10no.1

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    Related research

    Keywords: Inflation-indexed bonds ; Treasury bonds ; Treasury notes ; Rate of return;

    References

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    1. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Debt," Cowles Foundation Discussion Papers 1125, Cowles Foundation for Research in Economics, Yale University.
    2. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
    3. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Data," Harvard Institute of Economic Research Working Papers 1758, Harvard - Institute of Economic Research.
    4. Dominique Dupont & Brian Sack, 1999. "The Treasury securities market: overview and recent development," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 785-806.
    5. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
    6. David W. Wilcox, 1998. "Policy Watch: The Introduction of Indexed Government Debt in the United States," Journal of Economic Perspectives, American Economic Association, vol. 12(1), pages 219-227, Winter.
    7. Pu Shen & Jonathan Corning, 2001. "Can TIPS help identify long-term inflation expectations?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 61-87.
    8. Brian Sack, 2000. "Deriving inflation expectations from nominal and inflation-indexed Treasury yields," Finance and Economics Discussion Series 2000-33, Board of Governors of the Federal Reserve System (U.S.).
    9. J. Huston McCulloch, 2001. "The Inflation Premium implicit in the US Real and Nominal," Computing in Economics and Finance 2001 210, Society for Computational Economics.
    10. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-30, December.
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    Cited by:
    1. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR & CES & MSH, vol. 25, pages 755-806, October.
    2. Jens H.E. Christensen & James M. Gillan, 2011. "A model-independent maximum range for the liquidity correction of TIPS yields," Working Paper Series 2011-16, Federal Reserve Bank of San Francisco.
    3. Christensen, Ian & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Working Papers 04-43, Bank of Canada.
    4. Serge Jeanneau & Camilo E Tovar, 2008. "Latin America’s local currency bond markets: an overview," BIS Papers chapters, in: Bank for International Settlements (ed.), New financing trends in Latin America: a bumpy road towards stability, volume 36, pages 46-64 Bank for International Settlements.
    5. Daniel L. Thornton, 2007. "The lower and upper bounds of the Federal Open Market Committee's long-run inflation objective," Review, Federal Reserve Bank of St. Louis, issue May, pages 183-194.
    6. Linda S. Goldberg & Michael W. Klein, 2005. "Establishing Credibility: Evolving Perceptions of the European Central Bank," The Institute for International Integration Studies Discussion Paper Series iiisdp105, IIIS.
    7. Gurkaynak, Refet S. & Sack, Brian & Wright, Jonathan H., 2007. "The U.S. Treasury yield curve: 1961 to the present," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2291-2304, November.
    8. Serge Jeanneau & Camilo E Tovar, 2006. "Domestic bond markets in Latin America: achievements and challenges," BIS Quarterly Review, Bank for International Settlements, June.
    9. Cartea, Álvaro & Saúl, Jonatan & Toro, Juan, 2012. "Optimal portfolio choice in real terms: Measuring the benefits of TIPS," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 721-740.
    10. Joyce, Michael A.S. & Lildholdt, Peter & Sorensen, Steffen, 2010. "Extracting inflation expectations and inflation risk premia from the term structure: A joint model of the UK nominal and real yield curves," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 281-294, February.
    11. Refet S. G�rkaynak & Brian Sack & Jonathan H. Wright, 2010. "The TIPS Yield Curve and Inflation Compensation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 70-92, January.
    12. Kosuke Aoki & Takeshi Kimura, 2008. "Central bank's two-way communication with the public and inflation dynamics," LSE Research Online Documents on Economics 25483, London School of Economics and Political Science, LSE Library.

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