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bonds: Zvi Bodie's reply to Bill Bernstein. Reprinted with permission. Dear Bill: I just read your essay "Zvi Bodie and the Keynes' Paradox of Thrift" at http://www.efficientfrontier.com/ef/903/bodie.htm. In it you both praise and criticize the new book I have written with Michael Clowes, Worry-Free Investing: A Safe Approach to Achieving Your Lifetime Financial Goals. Naturally, I enjoy the praise, and I thank you for it. I enjoyed the criticism a bit less, but I thank you for it too. At first it struck me as odd that you would criticize the book for not doing what it was never intended to do. After all, WFI is a guidebook intended to inform individual investors about the new inflation-protected bonds that have emerged since 1997. It is not about market equilibrium or public policy. Upon reflection, however, I have concluded that we should have briefly addressed the general equilibrium and public-policy implications of the investment strategies we presented. If there is a second edition, we will surely do this. I must say that I do not agree with the conclusions in your essay. As you are probably well aware, the issuance of inflation-protected bonds by the U.S. Treasury has long been advocated by respected economists from both ends of the ideological spectrum. It was one of the few policy issues on which both James Tobin and Milton Friedman could agree. In an earlier era, Irving Fisher advocated it too. I am not sure what Keynes thought about it. My guess is that he would have approved. The vast majority of economists believe that general welfare improves when the number of distinct competitive markets increases. A market for inflation-linked bonds makes possible improved price discovery and a broader set of opportunities for the trading of risks. The real interest rates which clear this market are not completely predictable and will change over time in reaction to all sorts of demand and supply factors. I do not know what the "best" level for these rates is. One thing I do know for sure, however, is that Keynes meant his "paradox of thrift" to apply only to a situation in which there is substantial involuntary unemployment as in the early 1930s in the UK and the rest of the economically developed world. His later writings --from the World War II period-- make it clear that he did not think it relevant to an economy experiencing full employment. I would argue that in the U.S. we are currently much closer to a situation of full employment than to the situation that existed during the 1930s. Best Regards, Zvi Bodie ---------- Regards Ellis Originally posted in thread: 30203

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