Inflation & Inflation Expectations

Here are a couple of slides, courtesy of my colleague Kevin Kleisen. The first depicts recent U.S. inflation, both core and headline.

So, following a rather sharp decline in the headline CPI rate, we see an even sharper increase more recently. The core measure, however, remains relatively low and stable.

This next graph depicts a variety of market-based measures of inflation expectations. You may recall that the Fed was recently concerned that inflation expectations were drifting too low (relative to the implicitly desired target or around 2%). Inflation expectations now appear to have converged to pre-crisis levels. One could make a legitimate case that to the extent this was a part of the goal for QE2, the policy was a success.

Of course, the fear that many people have is that inflation may somehow get out of control. It is a legitimate concern and one that ranks high on the list of FOMC members.

And then there are a host of other concerns, like the ones outlined here by Pimco Managing Director Bill Gross: Economy May Reverse Course When Fed Buying Ends. I especially like this quote:

“Who will buy Treasuries when the Fed doesn’t?” he asked. “I don’t know.”

I’m sure Mr. Gross is a smart guy. But statements like that just make him sound a tad foolish.

Think about it. A USD is the equivalent of a zero-interest-bearing small denomination Treasury bill. So when the Fed is purchasing longer dated Treasuries, what is it doing? It is selling zero-interest bills for (slightly) positive-interest bills. Would a deceleration in this asset-swap activity really have the dramatic effect Gross suggests? (He is suggesting a sharp spike in Treasury yields). I doubt it. In fact, the implied tightening is likely to keep a lid on inflation expectations and hence keep nominal interest rates low (via the Fisher effect).

But we shall see…

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About David Andolfatto 95 Articles

Affiliation: Simon Fraser University and St. Louis Fed

David Andolfatto is a Vice President in the Research Division of the Federal Reserve Bank of St. Louis. He is also a professor of economics at Simon Fraser University.

Professor Andolfatto earned his Ph.D. in economics from the University of Western Ontario in 1994, M.A. and B.B.A. from Simon Fraser University. He was associate professor at the University of Waterloo before moving to Simon Fraser University in 2000.

His current research is focused on reconciling theories of money and banking. His past research has examined questions relating to the business cycle, contract design, bank-runs, unemployment insurance, monetary policy regimes, endogenous debt constraints, and technology diffusion.

Visit: MacroMania, David Andolfatto's Page

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