The introduction by the U.S. Treasury of inflation-indexed notes was one of the most widely publicized innovations in the U.S. capital markets in recent years. Since their introduction in January 1997, $57 billion in 5-, 10-, and 30-year Treasury Inflation-Protected Securities (TIPS) has been issued, and the Treasury has recently announced that TIPS will also be offered as small-denomination savings bonds. Because both the coupon and the principal of TIPS vary with the consumer price index, the Treasury believes these notes will appeal to risk-averse investors seeking protection from inflation. Proponents of TIPS have argued that their issuance should also reduce the cost of borrowing to the Treasury and permit a clear measure of investors' forecasts of inflation.

Despite their promise, it is doubtful whether inflation-indexed bonds have been a great success either in the United States or in other industrialized countries that have issued them. The authors analyze the characteristics of TIPS that might explain their limited acceptance. Their model indicates that TIPS should appeal primarily to risk-averse investors in high tax brackets who are pessimistic concerning inflation. Despite their unique design, however, TIPS are not unique in offering investors inflation-protected returns.