Inflation and other market factors affect the amount of interest customers can expect to earn on their investments. Treasury securities, backed by the federal government, function as secure interest-bearing investments with a guaranteed return on principal.
The inflation rate can be defined simply as the changing rate of prices, calculated on a monthly or yearly basis. The rise in prices is measured by comparing the Consumer Price Index or CPI for different periods.
Causes of Inflation
Inflation or more specifically, monetary inflation, is generally due to an increase in money being circulated. This means more deposits held in foreign banks and more cash in savings and checking accounts. If the government increases circulating money faster than companies can manufacture enough goods, more people demand the goods since more money exists to pay for them and this pushes prices higher. Additionally, since the amount of money in circulation has increased, each dollar has less value and every business must raise its prices just to get the same value it used to get for its products.
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Treasury bills, sometimes called T-bills, function as short-term investments issued by the federal government. They mature in periods of one, three or six months. The interest rate on T-bills is said to be "implied." This means that you buy the T-bill for less than its face value. At maturity, the difference between what you paid and the face value is the interest you earned.
Inflation's Effect on Interest
Inflation and the expectations of future inflation factor into the implied interest rates for T-bills. Historically, a period of relatively high inflation rates is usually associated with relatively high T-bill interest rates. The reverse scenario is also true.
Many additional factors cause T-bill rates to fluctuate up and down, such as supply and demand. When investors feel the stock market is too erratic or risky, they look for more stable places to put their money, and this creates a higher demand for T-bills, as less risky investments. Conversely, the government may choose to issue a higher supply of T-bills, and this will drive rates down since more have become available.
- Abstract U.S. Dollar Coins & Bills image by Andy Dean from Fotolia.com