WASHINGTON -- Federal Reserve Board Chairman Alan Greenspan yesterday endorsed issuing government bonds indexed to inflation to provide Fed officials with another tool for conducting monetary policy.
Appearing before the House Government Operations subcommittee on monetary affairs, Mr. Greenspan cautioned that it might take several years before the U.S. Treasury can issue inflation-indexed bonds. He added that the Treasury would have to proceed cautiously to make sure any new issues do not disrupt federal financing operations.
But on balance, he said, Fed officials like the idea of inflation-indexed bonds. Mr. Greenspan called such bonds "a window on the market's view of the path for inflation" that could help the central bank "considerably " in its efforts to forecast the economy.
Proposals to issue government debt indexed to inflation call for the Treasury to split some of its issues into two parts. One would be made up of regular bonds that are not indexed and the other would consist of bonds of the same maturity that guarantee to pay investors based on the consumer price index or some other widely accepted price measure.
Congressional supporters say inflation-indexed bonds would find plenty of appeal among investors seeking to hedge against risk and might help the Treasury lower its borrowing costs with debt at lower rates.
"They would certainly offer some investors a very attractive asset, and would find a wide and ready market," said Rep. Stephen Neal, D-N.C., chairman of the House Banking subcommittee on domestic monetary policy.
Mr. Neal, who also testified yesterday, told the panel that he would "push ahead with legislation" to require inflation-indexed bonds if the Treasury does not endorse the idea.
On a technical level, supporters say yield fluctuations on bonds indexed to inflation would provide the market with a ready measure of real interest rates. In addition, the gap between yields on indexed and non-indexed issues would provide a measure of inflation expectations.
The Treasury has authority under current law to issue inflation-indexed bonds but has refrained from doing so, arguing that any changes might disorient the market and drive up government borrowing costs. The Treasury rejected the idea in the early years of the Reagan administration under Secretary Donald Regan.
But Mr. Greenspan said the idea is doable, provided the Treasury committed to issuing a large enough volume of the new instruments to keep the government market as liquid as it is today, with narrow spreads between bid and ask prices.
"I would suspect that we could craft a set of issues which would be acceptable in the marketplace and solve the problems that we have," he told the panel. He recommended "a series of paired issues" with maturities "out to 20 years or longer," adding that he personally would like to see bonds with maturities up to 30 years.
Mr. Greenspan also said it would not be difficult for the Treasury to pick a single measure of inflation, such as the consumer price index, and to have the Internal Revenue Service issue rules clarifying tax treatment of the bonds.
In other comments, Mr. Greenspan repeated his optimism that the long-term trend on inflation is down and expressed frustration that bond market participants remain skeptical, keeping rates high.
"The U.S. economy has made considerable progress toward price stability over the past decade, trimming the core rate of inflation to below 4%, and it appears poised to make further advances," he told the subcommittee.
The Labor Department reported Tuesday that the consumer price index rose a meek 0.1% in May and that the core rate of inflation, or prices excluding food and energy, were up 3.8% compared to a year earlier.
But, Mr. Greenspan said, "There is a significant inflation premium in the long end of the bond market," which Fed officials suspect reflects fears that inflation will be rekindled in the next five or 10 years, "as opposed to the next year or two." Inflation-indexed bonds would help get a reading on inflation expectations along different portions of the yield curve, he said.
Treasury officials had no comment on Mr. Greenspan's testimony. Jerome Powell, undersecretary for finance, is scheduled to testify before the subcommittee on the subject of indexed bonds next week.
Government bonds indexed to inflation have met with mixed success in other industrial countries. In the United Kingdom, indexed "gilts" now account for about 20% of all outstanding government issues, and the market for the bonds is highly liquid.
