Do Federal Reserve inflation targets eliminate the need for inflation protection?

Monday, June 12th, 2006
Categorized as: Savings Bonds and competitive investments

What is your stance on Bernanke’s goal of keeping inflation limited to 1%-2%? If he is successful, wouldn’t that virtually eliminate the need for TIPS and I-bonds?

Tom’s response

Do you expect your house to burn down? If you’re like most people, you would rate the chances of that happening to be almost zero. Nonetheless, like most people, you have fire insurance.

Do you expect hyperinflation? If you’re like most people, you would rate the chances of that happening to be almost zero. The difference is that hardly anyone has inflation insurance.

The point of investing in Series I bonds is that you give up the chance of earning more in exchange for the certainty of getting back all of your money, with interest, no matter what happens with inflation.

TIPS are similar, but, unlike I bonds, they don’t protect you from potential capital losses (or gains) caused by changes in the prevailing level of interest rates.

If Federal Reserve Chairman Ben Bernanke meets his inflation goal, it just means we bought fire insurance and the house didn’t burn down. We’re always better off when the house doesn’t burn down, even if we paid in advance for insurance.

Rate this post (1 to 5 stars):  1 Star2 Stars3 Stars4 Stars5 Stars
(Average rating: 5.00 stars)
Loading...

FDIC Insured Certificates of Deposit can pay 1 or 2% more than savings bonds when held for a similar length of time. See top CD Rates Below:

5 Comments

On June 12th, 2006 Sam said:

Only time will tell if Bernanke can contain inflation to 1% to 2%. But if he does, wouldn’t the fixed rate on the I bond have to increase significantly for the EE to not be the better investment?

On June 13th, 2006 Tom Adams said:

Sam – With EE rates at 3.7% and the I bond fixed base-rate at 1.4%, inflation has to average just 2.3% for I bonds to be the better deal.

Keep in mind that when the Bernanke and other Federal Reserve board members talk about holding inflation to 1% to 2%, they’re talking about core inflation, which is the CPI minus changes in food and energy prices. The I bond rate, on the other hand, is based on the entire CPI, including the food and energy components.

Even over the last 10 years, a period during which inflation has been at historic lows, the CPI component has added slightly over 2.5% to I bond yields. Extending the period back so that it includes periods with more typical inflation levels results in the CPI component adding a bit more than 4% to I bond yields.

On June 13th, 2006 Mario said:

Tom, any advice on what a good portfolio percentage of inflation indexed bonds might be? I’ve read 10-15% in Money Magazine, but have >90% right now, and am wondering if I’ve got too much insurance.

By the way, the Fed chairman’s name is Bernanke, but I’m sure you all knew that.

On June 13th, 2006 Tom Adams said:

Mario – thanks for the spelling help! I’ve fixed the errors.

I don’t think there’s a one-size-fits-all answer to your portfolio question. The best way to diversify your portfolio depends on your age, the size of your portfolio, and other factors. In general, the older you are and the smaller your portfolio, the more conservative you should be.

Risk is for the wealthy, who can absorb potential losses, and for the young, who have lots of time to recover from bad investments.

[…] Do Federal Reserve inflation targets eliminate the need for inflation protection? […]

Comments Closed

June 1, 2010

After six years, over 400 posts, 3,680 real comments, and over 90,000 spam comments (thank you, Akismet, for making managing a blog with comments possible), I am closing public comments on Savings-Bond-Advisor.com. I will contine to update the main articles on this site, but not the comments.

Virtually every question about Savings Bonds has been asked and answered on this site multiple times. Use the search feature (see the box in the gray area near the top of this page) or the detailed menu on the lower part of the home page to find the information you're looking for. If you have a copy of Savings Bond Advisor, you can ask me a question here.

Tom Adams

Savings Bond Calculator



Help

Savings Bond
Questions

Get an answer to your questions from the Treasury's Savings Bonds team.

Click below to ask a question.

Ask the Treasury

TreasuryDirect

Invest online in Savings Bonds or
marketable Treasury securities.

Deal directly with the U.S. Treasury.

More info

Enroll

Log in