Fed could target TIPS yields instead

John Cochrane of Chicago Univ has an option for Fed:

Instead, the Fed can target the thing it cares about – expected CPI inflation – rather than the price of gold. To do it, the Fed can target the spread between TIPS (Treasury Inflation Protected Securities) and regular Treasurys, or CPI futures prices. Here’s a simple example. Investors buy a CPI-linked security from the Fed for $10. If inflation comes out to the Fed’s target, they get their money back with interest, $10.10 at 1% interest. If inflation is 2 percent below target, the Fed pays $2 extra — $12.10. This pumps new money into the economy, with no offsetting decline in government debt, just like the helicopter drop. If inflation is 2 percent above target, investors only get back $8.10 – the Fed sucks $2 out of the economy at the end of the year. If investors think inflation will be below the Fed’s target, they buy a lot of these securities, and the Fed will print up a lot of money, and vice versa.

 One might object that these markets are small and undeveloped. I answer that is exactly why the Fed needs to start doing it now, so the markets are large and developed when the Fed really needs them. One might object that this is a pretty wild new proposal. I answer that we need such proposals if all conventional policies eventually run out of steam. And of course the details will be more complex than what I have outlined.

With TIPS yielding negative rates, I need to think how this will work out.

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