Inflation expectations are jointly falling?

Tuesday, July 13, 2010

As a global economic slowdown is very likely underway, inflation expectations are being watched closely.

David Beckworth comments on inflation expectations in the US using the Treasury Inflation-Protected Securities (TIPS) market (he commented previously on an alternate measure of inflation expectations at the Federal Reserve Bank of Cleveland). He argues that the aggregate demand effect is the dominant factor dragging US inflation expectations.

However, inflation expectations are falling globally. The chart above illustrates the 10-yr break-even expected inflation rates for the UK, Germany, Canada, Italy, and the US using their respective inflation-indexed bond markets (TIPS in the US). Notably, declining inflation expectations is not specific to the US.

Of interest, the onset of the downward trend across break-even inflation rates coincides with policy announcements in Europe:

  1. the bailout of Greece, and
  2. the European Financial Stability Facility (EFSF)
Inflation expectations in Italy has taken the biggest hit, falling 55 basis points since May 2 2010 (as of June 12, 2010). But the trend has been broad-based, hitting even "sticky" UK inflation expectations.

The chart illustrates the same 10-yr inflation expectations rates as in the first chart but indexed to the start of 2010 for comparison.

Market participants in the UK, Germany, Canada, Italy, and the US reacted similarly to the European policy measures. The most likely reason for the drop in Eurozone country inflation expectations - Germany and Italy - is the direct adverse impact on aggregate demand of fiscal austerity measures and the indirect impact via trade. In the UK, Canada, and the US, the decline in the euro will have lagged and adverse impacts on relative trade patterns.

However, beyond the adverse impact on expected export income, it does seem that markets over-reacted a bit in the UK, Canada, and the US. Because the UK, Canada, and the US have one thing that Germany and Italy don't: fully sovereign policy. Domestic policy, monetary and fiscal, can offset the effects of the European crisis.

Rebecca Wilder


flow5 July 13, 2010 at 11:49 PM  

In the 4th qtr inflation expectations will revert to deflationary expectations.  The Federal Reserve cannot make accurate economic forecasts.  They exhibit a "wait & see" policy.

Contrary to economic theory and Nobel Laureate Miltion Friedman, monetary lags are not "long & variable".  The lags for monetary flows (MVt), i.e., the proxies for (1) reak growth, and for (2) inflation indices, are historically, alwasy, fixed in length.

It is an incontrovertible fact (as it now stands), that nominal gDp will cascade through-out the 4th qtr (down in every month - Oct, Nov, & Dec).   Without a slingshot (added montary & fiscal intervention/stimulus), the economy will never reach "escape velocity".   The bottom in this Great Recession is on July 2011. 

And according to monetarist guidelines, Greenspan never, ever, tightened up on monetary policy.  And Bernanke didn't start to ease policy when Bear Sterns 2 hedge funds collapsed, but waited until Lehman Brothers failed.  I.e., by Bernanke using "credit easing" as opposed to "quanitative easing", Bernanke drove our economy into a severe depression.

When the BOG eventually eliminates all required reserves it will be impossible for the FED to control the money suppply.  The only tool at the disposal of the monetary authority in a free capitalistic system through with the volume of money can be controlled is legal reseves.<span><span><span> </span></span></span>

flow5 July 14, 2010 at 10:27 AM  


If we are indeed on a dis-inflation, or deflationary -- path, Bernanke will again be a day late, and a dollar short.   We have a never ending stop-go monetary management:

rjs July 14, 2010 at 11:16 AM  

"Domestic policy, monetary and fiscal, <span>can</span> offset the effects of the European crisis."

good thing you qualified it with "can" because it looks increasingly unlikely that either offset will be forthcoming...

Rebecca July 14, 2010 at 12:42 PM  

Yes, rj. That's a very separate article! Rebecca

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