WASHINGTON - The House Government Operations Committee on Friday issued a report urging the Treasury Department to start issuing bonds indexed to inflation.

The bonds would help the Federal Reserve conduct monetary policy and "would most probably also reduce interest costs on the federal debt," the report says.

The panel's recommendations follow hearings that were held in June. During the hearings, Federal Reserve Board Chairman Alan Greenspan cautiously endorsed the concept of indexed bonds, while Treasury Undersecretary Jerome Powell argued against the idea.

Indexed bonds would adjust principal and interest payments to investors based on a standard measure of inflation, such as the consumer price index. Proponents say they would lower federal debt costs because investors would not demand an "inflation premium" in the yield they are paid for the securities.

Proponents also say the Fed would be able to get new information on inflation expectations by checking yields on regular securities sold in the market against those of comparable inflation-indexed bonds.

Powell said in June that although the bonds would provide some additional market information to the Fed, they would be useless for setting monetary policy because they would not be actively traded. He said the bonds would serve a relatively narrow market segment, whereas the Treasury as a matter of policy likes to keep markets of its securities as broad as possible.

But the report from the Government Operations Committee rejected the Treasury's arguments, saying the department had not fully explained why inflation-indexed bonds would not help lower borrowing costs.

"The committee concludes that selective issuance of indexed securities, in a program designed to assist monetary policy, would most probably encounter substantial demand, with the result that Treasury financing costs on the federal debt would most probably be reduced," he report says.

In his testimony, Powell said the prospective market for the bonds would be largely tax-exempt investors, such as state pension funds and defined benefit funds. The report calls that view mistaken, saying the bonds might have a wider appeal to portfolio managers of tax-exempt and tax-deferred funds.

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