TIPS do adjust downward during deflation, but only to the original par “floor”. So a year or two of deflation will simply offset any preceding inflation augmentation.
I think that, simply put, there are two possibilities:
1) The central bank is just a branch of the government. When it buys debt and issues money/reserves, this is just a liability restructuring. The balance sheet is basically an accounting fiction. Compare with a company buying back / holding its own shares.
2) The central bank is a fully independent entity. The balance sheet is real. Compare with a company that buys up inflation-indexed debt funded by equity. The value of equity depends on the value of the debt.
I can't see us having another 1930s type deflation. Should a crash occur and people start losing jobs, the Fed and Congress will pour tons of dollars into the economy thus creating horrendous inflation and cause the dollar to slump.
Getting wisps of both backing theory and market monetarism on targeting the spread - Somehow you have summoned both Mike Sproul and Scott Sumner to enter the chat
The so called “break even” inflation expectations measure has not been of value in the past. It bearly budged over the last 10 years while inflation varied enormously. In light of that fact, why would targeting that number have any meaning?
Yes, inflation does seem to be awfully unpredictable. If I could find a way to tie the value of the dollar to the current price level rather than the future price level, as gold or commodity standards do, I would do it.
My main interest is to be able to judge the proper level of interest rates. To do this I have found over many years to use ACTUAL reported inflation. Using 5, 4, etc on yr/yr cpi inflation works well not just for US but for most major economies. Whenever actual interest rates deviate from 2% real plus inflation expectations, defined by weighted moving avg as defined above, one has a useful and value added insight. The bond market seems most interested in actual inflation that has been produced. . .Theory, not so much.
Supply looks like the practical limit in the US. TIPS are only about 7% of marketable Treasury debt, so the Fed would end up owning a big share of the market unless Treasury issued many more of them.
Treasury should issue many more of them. And drastically simplify them! As above, I like perpetuities with a coupon linked to the level of the CPI. Surely this level of Fed Treasury cooperation can be envisaged. "Hey, we'd like to swap our long term treasurys and MBS for some TIPS. Could you guys issue a bunch and we'll buy them?"
The UK is the cautionary case on supply: linkers were about a quarter of gilt issuance before 2018, and the government then cut that to around 15% to limit the budget's exposure to inflation shocks. A Fed swap would hand the Treasury exactly that exposure, so getting it to issue many more may be the harder half of the plan.
If the goal is to generate real backing and some kind of discipline to fiat money, why should the backed asset be a liability of the same government whose fiscal behavior we need to discipline?
TIPS do adjust downward during deflation, but only to the original par “floor”. So a year or two of deflation will simply offset any preceding inflation augmentation.
A few years ago I suggested something along these lines: that the ECB hold consumption-linked perpetuities:
https://gideonmagnus.medium.com/the-case-for-consumption-linked-perpetuities-in-the-eurozone-557779ece710
I think that, simply put, there are two possibilities:
1) The central bank is just a branch of the government. When it buys debt and issues money/reserves, this is just a liability restructuring. The balance sheet is basically an accounting fiction. Compare with a company buying back / holding its own shares.
2) The central bank is a fully independent entity. The balance sheet is real. Compare with a company that buys up inflation-indexed debt funded by equity. The value of equity depends on the value of the debt.
I think we essentially live in world 1.
You'll never have to worry about deflation in the US. Regular TIPS will work fine.
Lots of people worried about deflation in 2008. Not me, but the deflation spiral was conventional wisdom. And there was a big deflation in the 1930s.
I can't see us having another 1930s type deflation. Should a crash occur and people start losing jobs, the Fed and Congress will pour tons of dollars into the economy thus creating horrendous inflation and cause the dollar to slump.
Getting wisps of both backing theory and market monetarism on targeting the spread - Somehow you have summoned both Mike Sproul and Scott Sumner to enter the chat
State Treasuries should also consider it
A severe case of "Money Illusion".
The so called “break even” inflation expectations measure has not been of value in the past. It bearly budged over the last 10 years while inflation varied enormously. In light of that fact, why would targeting that number have any meaning?
Yes, inflation does seem to be awfully unpredictable. If I could find a way to tie the value of the dollar to the current price level rather than the future price level, as gold or commodity standards do, I would do it.
My main interest is to be able to judge the proper level of interest rates. To do this I have found over many years to use ACTUAL reported inflation. Using 5, 4, etc on yr/yr cpi inflation works well not just for US but for most major economies. Whenever actual interest rates deviate from 2% real plus inflation expectations, defined by weighted moving avg as defined above, one has a useful and value added insight. The bond market seems most interested in actual inflation that has been produced. . .Theory, not so much.
Supply looks like the practical limit in the US. TIPS are only about 7% of marketable Treasury debt, so the Fed would end up owning a big share of the market unless Treasury issued many more of them.
Treasury should issue many more of them. And drastically simplify them! As above, I like perpetuities with a coupon linked to the level of the CPI. Surely this level of Fed Treasury cooperation can be envisaged. "Hey, we'd like to swap our long term treasurys and MBS for some TIPS. Could you guys issue a bunch and we'll buy them?"
The UK is the cautionary case on supply: linkers were about a quarter of gilt issuance before 2018, and the government then cut that to around 15% to limit the budget's exposure to inflation shocks. A Fed swap would hand the Treasury exactly that exposure, so getting it to issue many more may be the harder half of the plan.
I think, the central bank should accept money-supply protected treasuries only. :-)
If the goal is to generate real backing and some kind of discipline to fiat money, why should the backed asset be a liability of the same government whose fiscal behavior we need to discipline?
Just back it with hard money.