Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Tuesday, September 18, 2012

QE3 and Inflation Expectations

Some interesting data here on the TIPS measure of expected inflation following the Fed's QE3 announcement (courtesy of my colleague, Kevin Kliesen).

The first chart shows that the announcement had a significant impact on inflation expectations at short and long horizons.

Here's the same data, together with the 10-year inflation forecast, and for a longer sample period.

The impact on real yields, especially at the short end, seems significant (but let's see how long this lasts). 

Here's the same data over an even longer sample period.

And here's a truly remarkable graph...

Notes: Inflation-Indexed Treasury Yield Spreads are a measure of inflation compensation at those horizons, and it is simply the nominal constant maturity yield less the real constant maturity yield. Daily data and descriptions are available at See also Statistical Supplement to the Federal Reserve Bulletin, table 1.35. The URL for MT is:


  1. How does the -1.7% real yield affect the "below-market natural rate" explanation of UE? -1.7% seems very low for 5yr real yields. I doubt they have been lower. Is the "labor market clearing" rate -5%? This implies that, on the margin, corporate CFO's can find no investment that can return, on a risk adjusted basis, more than -5% p.a. I could see how this might be the case in the middle of a collapse in corporate profits; but not at cyclical peaks. Further, P/E's and corporate credit spreads are normal, as are junk bond spreads: indications abound that risk premia are not abnormally high.

    Even in 1933, I'm not sure the 5yr real rate fell much below zero before it sparked a significant decline in the unemployment rate.

  2. To be clear, I was referring above to a hypothetical 5yr forward real rate in 1933, post gold standard exit. I suppose one could make the case that ex-ante inflation expectations then were much higher than ex-post inflation.

  3. David, awesome charts, thank you very much for your efforts.

  4. If the goal is employment, why doesn't the Fed buy corporate and venture debt from companies that are using those funds to hire employees. That is, the Fed can buy corporate and venture debt to force those rates low and particular purchase debt of business who are hiring or starting new ventures.

    This would seem to impact employment more directly than say buying MBS or Treasuries that have a more obscure relation to employment.

  5. Hey David

    Long time since I commented here but these are my thoughts on inflation expectations and how any of these graphs might relate to the type of economic recovery that is hoped for by these actions.

    Here are 3 different ways expectations might matter, or 3 ways changed expectations need to work in order to be effective

    Workers and their income and spending/saving habits must change.

    Do people think that people actually expect higher future incomes to go along with their expectations of higher inflation? Is the income channel driven by the inflation expectations channel? I can tell you that most people working for someone else, people who rely on a paycheck from someone (most people) do NOT believe that their paycheck will rise in tandem with inflation. They feel poorer as inflation expectations rise (and they are in real terms quite often) and they will NOT spend more today because they fear high future prices. Additionally, since the primary way our leaders see a spending recovery happening is via borrowing activities of consumers and businesses, unless we actually HAVE more income, not just expect it, we will not take on more debt.

    How about the owners of a business and their hiring decisions;

    Will they behave in a way that induces them to spend/invest as their expectations of future inflation increases? Doubtful. If they think future costs will be higher, they will likely cut present costs, and it looks as if the story of the last few years bears that out. One could say that if all their assets become more valuable, like the land their factory/office is on or the value of the share price of their stock, (which only matters to a publicly traded company and many are employed in untraded companies) the improvement in their balance sheets will spur activity, but we'll see. Mostly I think they want more customers with money. Where they gonna come from?

    Thirdly entrepreneurs ;
    I have come to the conclusion that what these inflation expectations economists really believe is that they see the drivers of our economies as those that take the big risks (true to a degree for sure), those that shoot big….. and they see our economies fate as tied to these "benevolent financial dictators" so to speak. We must rely on these extremely successful entrepreneurs to do the right thing and protect their investments and not get in their way. Its these guys’ inflation expectations that drive things because these guys are real sensitive to the erosion of inflation on their investments. If they see inflation in the future they will spend now to get the best deal they can.

    This may be how a small segment of the population sees things and we will see if rising inflation expectations gives them a sense of urgency to do something productive now.

    As a "concrete steppes" guy I dont think monetary policy is completely ineffective, I just think its clumsy, fraught with very bad side affects and too top down. I see it as actually more top down than fiscal policy, which interestingly is the criticism of fiscal policy by many monetarists. Just a different view of things? Or is there an actual definition of “top down” that can be discerned ?

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