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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
The best-known example of such adjustment is the use of the CPI-U to index the value of certain U.S. Treasury securities.
In 1997 the U.S. Treasury, responding to the demand for an asset that combined the safety of Treasury securities with inflation protection, began to issue marketable 5- and 10-year notes and 30-year bonds called Treasury Inflation-Protected Securities (TIPS). By the end of 2000, $121 billion of such securities had been issued, which was 4 percent of the Treasury’s total marketable securities. Such securities are held by investors both directly and through such interme-diaries as mutual funds and pension plans.18
The TIPS are sold, and their interest rates determined, at a single-price auction of the kind used for Treasury’s other marketable securities. The principal is indexed to the seasonally unadjusted CPI-U (lagged approximately 3 months), and at maturity the securities are redeemed at the greater of their inflation-adjusted principal or their original par value. The interest rate is fixed for the term of the security, and interest is paid semiannually on the inflation-adjusted principal. Both interest payments and any adjustment to the principal are subject to federal income tax in the year they occur, but they are exempt from state and local taxes.
Since individuals, organizations, and institutions save for a wide variety of purposes, the use of a broad index of general inflation for indexation seems appropriate. Arguably, the GDP price index, which covers all final goods and services, would provide the broadest protection against price changes. However, since the projected need to maintain household consumption expenditures in retirement is a major motivation for individual savings, the CPI is a quite logical alternative. In addition—and perhaps more important—the CPI’s familiarity to the public, monthly availability, and freedom from revision provide a strong rationale for its use. Obviously, a broad index like the CPI cannot fully meet the indexing needs of savers with specific and narrower savings goals, such as the college education of children or the purchase of a retirement home. In such cases, investment vehicles that more nearly track the costs of the goods in question, such as real estate investment trusts or state or college prepaid tuition programs, might be more appropriate.
The large investors and institutions that play a major role in the market for Treasury securities will be aware of methodological revisions in the CPI and build them into their expectations about the future rate of measured inflation. Given no change in the rate of inflation expected under the unrevised methodology, the revisions should lead to different auction prices and effective interest yields for TIPS relative to those on other securities than would otherwise have prevailed. An investor will receive a different initial coupon yield and an offsetting difference in the inflation adjustment. However, revisions in CPI methodol-
Inflation-adjusted U.S. savings bonds (Series I) are also available.