Inflation Expectations Have Fallen Since 2019

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Greg Ip recently wrote in the Wall Street Journal that “anxiety about inflation is at a fever pitch, among economists and in markets.” (Some of that anxiety has been voiced around here.) Ip includes a graph that seems to back up the worriers. It uses the difference in yields between Treasury bonds that are indexed for inflation and those that are not to derive the market’s implicit projection of future inflation. The graph seems to show that expected inflation, as measured by the Consumer Price Index, plunged when the pandemic hit but has subsequently more than made up its lost ground.

You can look at a more extended version of the graph here. It shows expected CPI inflation running at 2.45 percent annually for the next five years, which is as high as it has been since the spring of 2011. The Fed says it would like inflation to average 2 percent per year, but it uses a different measure of inflation based on Personal Consumption Expenditures. PCE inflation tends to lower than CPI inflation, and so the yield difference seems to suggest that the Fed will be just a bit above its target over the next five years.

The Fed knows, though, that its own purchases of inflation-adjusted bonds can muddy the message of the market by increasing its liquidity and decreasing yields. That makes the market’s projection of inflation look larger than it is. The Fed also publishes a data series that attempts to correct for this distortion (which is available at the bottom of the page in the previous link). The firm Cornerstone Macro, which uses a similar method and reaches similar results but has more up-to-the-minute estimates, has kindly given me its latest numbers. As of yesterday, its estimate is that the market is projecting 1.67 percent CPI inflation over the next five years.

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Based on this calculation, the market expectation of inflation over the next five years remains well below the Fed’s target. (Remember, CPI inflation usually runs higher than PCE inflation.) The trend also looks different. Expected inflation, adjusting for liquidity, was 1.83 percent at the end of 2019. It plunged during the pandemic — all versions of the data show that — but it has not fully recovered. (David Beckworth and I wrote as much in the New York Times recently.)

If we believe a) that market expectations of future inflation are more likely to be correct than the theories of any group of commentators, even highly informed ones, and b) that this method of adjustment to yield differentials gives us as good an estimate of market expectations are we have, then it follows that we don’t have any more reason for anxiety about high inflation than we had at the end of 2019 — when there was a lot less of it. And even if we doubt both of those premises, the yield differential, with no adjustment for liquidity, doesn’t give us a positive reason for that anxiety. The concern that high inflation is on the way is based, at least in part, on a statistical mistake.

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.


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