Tuesday, December 2, 2008

Greg Mankiw's Blog: Real interest rates plunge!

Greg Mankiw's Blog: Real interest rates plunge!

TIPS offer asymmetric inflation-protection. If the price level rises, your principal rises as well. But if the price level goes down, you get your initial nominal principal back. (Don't believe me? Click here.) A new TIPS bond is great when there is risk of deflation. It is a real bond if prices go up, but more like a nominal bond if prices go down. Heads you win, tails you win also.

An older TIPS bond, however, is not as attractive. A lot of price inflation is already built into the adjusted principal. All of that inflation has to be undone by subsequent deflation before the nominal floor on the principal kicks in. As a result, when there is risk of deflation, the older bond has to offer a higher yield to compete with a newer one.

In other words, after a period of inflation, an older TIPS is closer to a true real bond, whereas a new TIPS is an attractive hybrid. This fact could explain the large jump down in the inferred real interest rate when the Treasury changed the raw bond data it uses. And it can explain why the issue became significant only recently, as people have started to seriously worry about deflation, inducing Treasury to change its calculations.

Cool what he is saying is that true real bonds are old hags, lots of inbuilt baggage; worn out and new bond is attractive hybrid mistress bonds no baggage. New bond is more nothing to loss, either side coin you win, gosh indeed attractive slut, not one side but goes every where. Hag bonds risky because not only inbuilt in baggage she carries, but also when deflation, must grantee a higher yield for competing mistress TIPs. Hehe, whoever hold old hags as investment is losers and who has new mistress bond winners of life. Why not then people is not ditch their old hag? That is question