This prediction is supported by empirical studies that have examined the premium that investors pay for inflation protection both in the United States and elsewhere. For example, a study by Brian Sack of Macroeconomic Advisors finds that forward breakeven inflation rates increase as maturity lengthens. In contrast, the level of survey-based measures of inflation expectations is quite constant beyond a time horizon of a few years. This means that the difference between forward breakeven inflation and inflation expectations climbs as the time horizon extends. This strongly suggests that the premium investors pay for inflation protection increases as maturities lengthen. Second, it may make sense to structure the TIPS program in a way that would help reduce the illiquidity premium associated with TIPS relative to on-the-run nominal Treasuries. Some of the current illiquidity premium is likely to shrink as financial markets stabilize. However, further improvements may require a change in either the structure of the TIPS program or the secondary market trading environment. On that note, I leave you with two outstanding questions: 1)  What are the best ways for the U.S. Treasury and the trading community to improve secondary market liquidity in TIPS? 2)  Given that TIPS appear attractive for the U.S. Treasury, what is the optimal allocation of the Treasury’s liability portfolio between TIPS and nominal securities? Thank you for your attention. 6  BIS Review 14/2009
Changes in monetary and financial conditions Overall, monetary conditions are a reflection of our expansionary policy, especially with respect to interest rates and the monetary aggregates. BIS Review 167/2009  1  The Libor is currently at the level targeted since March this year, i.e. 25 basis points, a level which can be regarded as a floor. The fact that it was impossible to bring the rate down any lower than this led us, in March, to introduce other instruments in order to make our monetary policy as expansionary as the circumstances demanded. Monetary conditions have become more expansionary via the interest rate channel in particular. Indeed, credit premia on the capital markets have declined steadily since the beginning of the year. As yields on Confederation bonds have remained low, other long-term yields have also trended downwards. It has thus become cheaper for companies to raise funds by borrowing on the capital market. In addition, our figures show that financing in the form of bank loans has also become more attractive following the decline in the Libor. In real terms – i.e. after factoring in expected inflation – interest rates are even lower. The Swiss franc has appreciated slightly in trade-weighted terms, as a result of the recent weakening of the dollar. However, it has remained stable against the euro, which shows that the monetary policy followed since March has been effective.