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Inflation-Resistant Government Bond Being Weighed : Securities: A House subcommittee is preparing a proposal for creating an issue linked to the consumer price index.

From Associated Press

The bond market’s biggest demon--inflation--may be exorcised by a new type of government bond being considered in Washington.

A House subcommittee is preparing a proposal for the Treasury Department that suggests splitting government bond issues into two categories. One would be the standard bond now used to borrow money from the public to pay for government operations. The other would also be used to fund the government, but its interest and principal payments would be tied to the consumer price index.

The value of a bond with a fixed return erodes over time as inflation creeps higher or if market interest rates rise. With longer-term bonds, there is a greater chance inflation will build and investors will demand higher yields.

A bond with returns that automatically rise with inflation would remove much of the market’s unpredictability. The new bonds would provide a measure of the market’s inflation expectations and a guide to real interest rates.

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Doug Barnard Jr., a Georgia Democrat and chairman of the commerce subcommittee of the House Committee on Government Operations, is exploring the idea, and his staff is preparing to ask Treasury officials for their opinion.

A barometer of inflation expectations and real interest rates would be a valuable tool for policy-makers as they try to encourage growth in the economy without accelerating price increases.

In a recent letter to Barnard, Alan Greenspan, chairman of the Federal Reserve Board, which has influence over short-term interest rates and guides the country’s monetary policy, said he was not sure the bond would help determine economic policy.

“We have to evaluate whether the costs of obtaining the information would be worth the benefits,” Greenspan said. “By this standard, my colleagues and I have some doubts that the information we could realistically hope to glean . . . would outweigh the potentially major costs of implementing the change.”

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An aide on Barnard’s subcommittee said that Greenspan’s letter has not dissuaded the effort and that there was some positive feedback for the subcommittee.

In his letter, Greenspan said the bonds’ ability to show inflation sentiment and real interest rates would be tainted by differing demand for indexed and non-indexed bonds.

However, Greenspan said, the indexed bond would give a rough approximation of inflation expections.

“An accurate, market-based measure of inflation expectations would aid immeasurably in understanding economic developments and in steering policy. Even an imperfect measure could be useful, provided it were treated with the appropriate degree of skepticism,” Greenspan said.

But the Fed chairman warned that a new breed of Treasury bond could increase the government’s borrowing costs.

Buyers and sellers have an easier time getting together in the Treasury market than any market in the world. Part of the reason, Greenspan said, was that Treasury bonds are all close substitutes for each other.

“Any novel instrument initially would be less liquid and ultimately may lead to some fragmentation of trading in government securities, perhaps raising overall funding costs,” Greenspan said.


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