Some studies suggest that the issuance of Treasury Inflation-Protected Securities (TIPS) -- inflation-indexed debt -- has not been as cost-effective for the Treasury as the issuance of nominal securities. The studies base their conclusions on ex post analysis, that is, they look back from the actual inflation outcome to determine whether TIPS issuance costs exceeded the costs of nominal Treasury issuances of similar durations. This article argues that the ex post approach has drawbacks when it comes to assessing the costs and benefits of TIPS over the long run; instead, an ex ante approach is recommended. A comprehensive analysis of TIPS should also consider the program's other, more difficult-to-quantify, benefits -- especially when cost analysis shows that TIPS are only marginally more expensive or about as expensive as nominal issuances. The ex ante costs of TIPS issuance are found to be about equal to the costs of nominal Treasury issuance; moreover, TIPS provide meaningful benefits to investors and policymakers.
William C. Dudley, Jennifer Roush, and Michelle Steinberg Ezer The Case for TIPS: An Examination of the Costs and Benefits • Some studies suggest that the issuance of Treasury Inflation-Protected Securities (TIPS)— 1. Introduction inflation-indexed debt—has not been as cost- effective for the Treasury as the issuance of nominal securities. S lightly more than a decade has passed since the inaugural issuance of inflation-indexed debt by the U.S. Treasury Department. Eleven years and thirty issues later, we are at a • The studies base their conclusions on ex post good vantage point from which to evaluate the successes and analysis, that is, they look back from the actual failures of the Treasury Inflation-Protected Securities (TIPS) inflation outcome to determine whether TIPS program. issuance costs exceeded the costs of nominal From a purely financial perspective, a number of recent Treasury issuances of similar durations. studies have suggested that the program has been a disappointment. After calculating the direct costs of TIPS • This article argues that the ex post approach issuance relative to issuance of nominal Treasury securities, the has drawbacks when it comes to assessing the studies show that the first ten years of the TIPS program have costs and benefits of TIPS over the long run; cost the Treasury billions of dollars (Sack and Elsasser 2004; instead, an ex ante approach is recommended. Roush 2008). Importantly, these studies rely entirely on ex post analysis. • A comprehensive analysis of TIPS should also In other words, the studies ask, Given the actual inflation consider the program’s other, more difficult- outcome, did the costs of TIPS issuances exceed the costs of to-quantify, benefits—especially when cost nominal Treasury issuances of similar durations? This analysis shows that TIPS are only marginally approach depends on the actual inflation outcome, which may more expensive or about as expensive as differ from expectations at the time the TIPS investment was nominal issuances. made because investors do not have perfect foresight of inflation. If investors underpredict actual inflation when • The ex ante costs of TIPS issuance are found to purchasing TIPS at auction, then these positive forecast errors be about equal to the costs of nominal Treasury would increase the payments that the Treasury has to make to issuance; moreover, TIPS provide meaningful benefits to investors and policymakers. William C. Dudley, president and chief executive officer of the Federal Reserve The authors thank James Clouse, Joshua Frost, Joseph Gagnon, Kenneth Bank of New York, was executive vice president and head of the Bank’s Garbade, Warren Hrung, Lorie Logan, Simon Potter, Anthony Rodrigues, Markets Group at the time this article was written; Jennifer Roush is chief Brian Sack, and Jonathan Wright for thoughtful comments and Brian Sack of the Monetary and Financial Market Analysis Section of the Board of for the data in Chart 5. The views expressed are those of the authors and do Governors of the Federal Reserve System; Michelle Steinberg Ezer is not necessarily reflect the position of the Federal Reserve Board, the Federal a senior trader/analyst in the Markets Group. Reserve Bank of New York, or the Federal Reserve System. Correspondence: <email@example.com> <firstname.lastname@example.org> FRBNY Economic Policy Review / July 2009 1 TIPS holders to compensate them for realized inflation.1, 2 Table 1 Upside inflation surprises tend to increase the ex post cost of Impact of Changes in Factors on TIPS issuing TIPS compared with nominal Treasuries. Break-Even Inflation While inflation forecast errors are relevant for calculating the actual costs incurred over the first ten years of the TIPS Impact on TIPS Break-Even Factor if Factor Increases program, we believe they are irrelevant in assessing the expected benefits or costs of the program over the long run—a Inflation
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