Anonymous econoblogger knzn has done a great job of moving the inflation-expectations story forwards with a blog entry actually looking at where Greg Ip’s numbers might be coming from. The reason for looking at inflation expectations between 2013 and 2018 is that they "strip out near-term inflation disturbances related to fluctuating energy and food prices". But that doesn’t mean it isn’t worth keep in eye on inflation expectations between now and 2013, if only for calibration purposes.
It turns out, after running the break-even inflation rate (BEI) numbers, that even as long-term inflation expectations seem to be rising, five-year inflation expectations are if anything coming down.
That should make you a little suspicious already. Think about those “near-term inflation disturbances related to fluctuating energy and food prices” that the Fed is trying to filter out. There has been a huge run-up in commodity prices over the past 6 months, and over the past 5 years. Presumably this should have more effect on the inflation rate over the next 5 years than it will on the inflation rate over the subsequent 5 years. If these BEI rates were unbiased indicators of expected inflation, you would probably expect the current BEI to be higher than the 5-year forward BEI…
Take a look specifically at the change between Jan. 9 and Jan. 30. The current 5-year BEI rate actually went down by 4 basis points. That observation, it seems to me, is rather hard to reconcile with a story that says investors were reacting to a dovish shift in Fed policy. Is there any way that a dovish shift could reduce the inflation rate over the next 5 years? Of course, the (inflationary) dovish shift might have been outweighed by (disinflationary) weak economic news. But in that case should we really be worrying about inflation expectations?
The main takeaway here is not that inflation isn’t a problem, but rather that inflation expectations are hard things to measure, even when you have parallel liquid markets in both Treasuries and TIPS. And that while policymakers can probably learn something by examining long-term trends in the TIPS rate, it’s not worth getting too excited about intramonth moves of a few basis points.