Turning first to the issue of measuring the impact of TIPS issuance on the government’s funding costs, this could be done simply by comparing the ex-post costs of a program of TIPS issuance to the costs of a comparable program of nominal Treasury issuance. Studies 1 of this sort have typically shown that TIPS issuance has resulted in a higher net cost to the Treasury. Unfortunately, although this methodology is attractive in its simplicity, it has some flaws that undercut its usefulness in reaching conclusions about the attractiveness of the TIPS program. The problem with an ex-post analysis is that it depends critically upon the performance of inflation over the period in question. If inflation turns out to have been meaningfully different than what was expected at the time of TIPS issuance, then this difference – the so-called “inflation surprise” – can be important in affecting the relative costs of TIPS versus nominal Treasury issuance. If inflation turns out to be higher than expected, then TIPS issuance will likely look to have been more expensive than nominal Treasury issuance. If inflation turns out lower, an ex-post analysis will likely show a savings from the TIPS program. Over the long run – and I mean the very long run – there should be roughly as many downward surprises in inflation performance as upward surprises. But within any relatively short period, such as the last decade, this certainly does not need to be the case.

Chart 1: Volatility of GDP and CPI Real GDP Growth  Per cent 5  CPI 4  3  2  1  0 79 81 83 85 87 89 91 93 95 97 99 01 03 05  BIS Review 84/2007  7  Chart 2: GDP and CPI fan charts from May 2006 Inflation Report  Chart 3: Corporate bond spreads Basis points 80  Basis points 350  High Yield corporations (RHS)  70  300  60  250  50  200  40 150  30 Emerging markets (RHS) 20 10  100  Investment Grade corportations (LHS)  50  0  0 Jan  2006  Apr  Jul  Oct  Jan  Apr  Jul  2007  Chart 4: Financial market liquidity  8  BIS Review 84/2007  Chart 5: Corporate bond spreads Basis points 180 High Yield corporations (RHS)  Basis points 900 800  160 140  700  Emerging markets (RHS)  120  600  100  500  80  400  60  300  40  200  Investment Grade corportations (LHS)  20  100 0  0 00  01  02  03  04  05  06  07  Chart 6: US sub-prime arrears Per cent  2000 2001 2002 2003 2004 2005 2006  12 10 8 6 4 2 0  0  5  10  15 20 25 30 Age in months  35  40  45  50  Chart 7: Spreads on ABX index Basis point s 3500 3000 2500 BBB-  2000 1500  BBB 1000 A  500 0  Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul 2006  BIS Review 84/2007  07  9  Chart 8: Real LBO loan issuance United Kingdom United States Rest of Western Europe Rest of world  $ billions, 2006 prices 300 250 200 150 100 50 0  86 88  90  92  94 96  98  00  06 (b)  02 04  Chart 9: Corporate bond, leveraged loans and sub-prime markets $ US and European leveraged loan markets US sub-prime European sub investment-grade bond US sub investment-grade bond European investment-grade bond US investment-grade bond  12000  10000  8000  6000  4000  2000  0 2002  2003  2004  2005  2006  Chart 10: Breakeven inflation forward rates % June MP C  4 3.75 3.5  20 year 10 year  3.25 3 5 year  2.75 2.5  May-06  10  Jul-06  Oct-06  Jan-07  Apr-07  BIS Review 84/2007  Chart 11: Inflation gaps Percentage changes on a year earlier 2.5 RPI-CPI 2.0 1.5 1.0 0.5 RPIX-CPI 0.0 -0.5 00  01  02  03  04  05  06  07  Chart 12: Official exchange reserves Ot her (Indonesia, Malaysia, P hilippines, T $ bn India 3500 Singapore Hong Kong 3000 Korea T aiwan 2500 Japan China OP EC, Rus, Kaz 2000 1500 1000 500  Dec00  Dec01  Dec02  Dec03  Dec04  Dec05  Dec06  Mar07  Chart 13: Lending to individuals % change oya  20 Unsecure d (16%)  18 16 14 12 10  Total  8 6 4 2  1994  BIS Review 84/2007  1996  1998  2000  2002  2004  2006  11  Chart 14: Commercial property capital values growth 30  Percentage change on previous year  25 20 15 10 5+ 0 5  -  10 15 20 80  12  83  86  89  92  95  98  01  04  07  BIS Review 84/2007