The Underrated Inflation Hedge

Fama and French discuss the relative merits of TIPS versus cash as inflation hedges.  Cash is an effective inflation hedge because short-term interest rates offer compensation for actual and expected inflation, with very low risk.  As French notes:

Because the one-month T-bill rate changes to accommodate changes in expected inflation, unexpected inflation does not have the compounding effect that it has with longer-term bonds.

Of course, this assumes that short-term interest rates remain market-determined rather than set by regulation.

posted on 27 January 2010 by skirchner in Economics, Financial Markets

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