More TIPS to Finance Our Growing Debt?

As you may noticed, the U.S. needs to borrow vast amounts of money. Which raises an interesting question: how should we finance that debt?

The Government Accountability Office (GAO) has taken note of this question and has begun a series of reports on debt management. In its first report, released today, the GAO provides a ringing endorsement of inflation-indexed bonds, aka TIPS (Treasury Inflation Protected Securities). The title of the report pretty much summarizes its conclusions: “Treasury Inflation Protected Securities Should Play a Heightened Role in Addressing Debt Management Challenges.”

The report provides a nice history of the TIPS program, which dates back to 1997, and the challenges it has faced. The number one challenge? Liquidity. Regular Treasury securities are the most liquid in the world and, as a result, investors are willing to pay a premium to own them. U.S. taxpayers thus benefit from the low interest rates our government has to pay on its debt. Unfortunately, TIPS are much less liquid and thus don’t enjoy the same benefit. GAO thus suggests that actions to improve liquidity (e.g., more frequent auctions) could help bring down interest costs.

GAO also recommends that longer-dated TIPS be issued as the U.S. moves to lengthen the maturity of its debt. As noted in the following chart, the current maturity structure of U.S. debt is heavily skewed to short maturities:

GAO - Debt Issuance

More than $3 trillion of U.S. debt will come due by the end of 2010 alone.

The reliance on short-term debt makes sense when near-term interest rates are incredibly low, as they have been lately. But interest rates will rise again one day (perhaps sooner than many anticipate according to a recent op-ed by Fed Governor Kevin Warsh), and the government should therefore be evaluating how it will lengthen maturities. GAO believes that TIPS should be part of that.

14 thoughts on “More TIPS to Finance Our Growing Debt?”

  1. It would help, albeit in a small way, if the tax treatment were changed so that individuals holding outside tax-deferred accounts didn’t incur phantom income.

  2. Lengthening the maturity of outstanding fixed interest US debt will increase inflation fears. A longer average maturity allows the US to inflate its debt away. Debt holders will not trust the Fed to keep inflation low while the US has a very high debt level.

    Interest costs on short-term debt and TIPS rise quickly in an inflationary environment and act as a constraint on the Fed’s loose monetary policies. Without Fed inflation control, rising debt costs will force tax increases or benefit program cuts to meet the higher interest expense. With short-term debt and TIPS, there is Fed incentive to control inflation and keep inflation expectations low.

  3. Interesting…how have other entities fared over the last few years that relied on short term funding for long term liabilities?

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  5. TIPS are much less liquid and thus don’t enjoy the same benefit. GAO thus suggests that actions to improve liquidity (e.g., more frequent auctions) could help bring down interest costs.

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