Semi-Daily Journal

So this is clearly not an unconditional commitment to low rates for a sustained period of time -- the low rates are linked to the continuing risk of a downward movement in inflation. Is that enough to keep long rates down?

Note the spreads between nominal treasuries and TIPS - in the 2.2%-2.7% for 5-30 years. Someone believes there's a risk of inflation increasing.

http://www.bloomberg.com/markets/rates/

What richard points to suggests that the Fed may be pushing on a string.

Richard, that breakeven inflation in "TIPS - [is] in the 2.2%-2.7% for 5-30 years." does *not* imply that "someone believes there's a risk of inflation increasing". It rather implies that someone believes there is a good chance that we will avoid having to low levels of inflation.

If some bond traders and art history students think that inflation is rising when it is falling, then that is their problem. This is the same crowd that just yesterday brought us the Fed-rhetoric-change hypothesis.

If you want to know the pace of inflation, observe the rate of change of the general price level. You can use the GDP deflator, the core PCE deflator, the core CPI, the core chained CPI or the Median CPI. These are imperfect measures, affected by owners' equivalent rent distortions, blah blah blah. But they beat the hell out of TIPS spreads, the copper price, the Baltic Freight Index or whatever is the flavor of the week among the 2-year note shorts. (I see that these same folks don't cite microprocessor prices or unit labor costs when pondering the "inflation pipeline.")

Anyhow, if you calculate and plot the 12-month rates of change of indexes that actually measure the underlying trend of the general price level, you will see that the lines slope from the top left of the chart to the lower right. That is called disinflation.

Of course, this could change. The standard models that predict further disinflation, such as those used at the Fed, are unreliable empirically and based on some dubious micro foundations. And we know now that the Fed wants higher inflation. Both Bernanke and Gramlich said as much this month, in Dallas and Toronto respectively. So maybe those longer-dated TIPS spreads are picking up something about the distant FUTURE.

But the discussion of inflation around the markets and among the ignorati seems to be innocent of its declining trend. Not that the good doctor DeLong said anything silly. He just raised a question.

This may be naive, but could we be having disinflation and asset inflation? Might that not lead to another burst bubble and then real deflation?

Mats, the spread between nominal treasuries and TIPS rises as time increases. Sure sounds as if "someone believes there's a risk of inflation increasing"

Gerard, why don't you believe that the spread between TIPS and nominal treasuries reflects the markets' expectation of future inflation risk? For example, if I believe 5 year inflation will be higher than the spread, I buy TIPS. If enough believe this the spread changes to reflect that belief.
One of the reasons TIPS were created was to give the gov't a measure of inflation expectations.

I understand the admonition to market professionals to accept the lesson that inflation indices are a better measure of price overall price movement than copper prices. What needs to be remembered is that all inflation indices measure the past and what market guys are trying to do is get a peak into the future. Unless you have a strong emotional attachment to trend following, looking at the fall in inflation over several years is not going to tell you what you want to know about future inflation.

For the broader public (the "ingorati"?), there is even less reason to scold about inflation "misconceptions." There has always been a strong emotional component to public perceptions of inflation. Tell folks that core inflation rates are a better measure of what is going on in the economy, or that excluding tobacco gives a cleaner read and the answer, very often, will be, "unless you have to by food, fuel and smokes." It is simply asking too much to have people ignore what they see in their own lives in favor of an index that involves calling rising computer prices a decline because clock speeds have gone up, or to have them accept that improved pollution control and safety in autos (along with stuffing in a bunch of microchips) means "real" auto prices aren't rising as fast as sticker prices. There is also a big risk of confirmation bias - we are far more prone to notice that overpriced coffee just got more overpriced than that pencil prices fell. Yes, the general public is very likely to misunderstand the construction and implication of standard inflation measures, but so what? They probably need to keep a closer eye on the prices of things that they actually buy and what changes means for their budget than they do to a seasonally/quality adjusted basket of goods.

When my office mates note that transit fare hikes, property tax hikes, cafeteria price hikes, energy costts and so on are making a hash of their household budget (no pay raises to make u pthe difference), they are saying something far more important (outside Fed policy making meetings and setting of price adjustments for Federal entitlement payments) than anything the CPI or the GDP deflator has to tell them.

The Fed is throwing ice water on Snow's interest rate comments from last week. Snow shows behavior all too common in CEOs- selective listening. Snow has surely been told that if employment does not increase, interest rates will remain low, but if the economy rockets forward and employment rapidly increases it will be followed by a rise in interest rates to head off inflation. Snow (and everyone else) are hoping for a more rapid recovery. He is convinced (at least publicly) of the most optimistic scenario and therefore is convinced that interest rates will rise. Snow got ahead of the game. The Fed by its comments is not looking for the job market to substantially improve over the short run.

Stan Collendar who writes a pretty good budget column (free to edu) discusses the political context of the Snow remarks.

http://nationaljournal.com/members/buzz/budget.htm

It is clear that Collendar too thinks that employment will increase. Maybe this is an East Coast perception bias and we will see regional recoveries with the East Coast leading and other regions lagging. The East Coast economy should be improving with the big increase in defense spending.

Here in the Chicago region, employment is as bleak as ever with steel and manufacturing continuing to shed jobs. The general perception is that the president and his East Coast advisors had no clue how detrimental the steel tariffs would be to an already diminishing manufacturing base.

Chicago/Midwest will recover with nano-technology, micro manufacturing and pharmaceuticals but it takes time and investment to transition out of steel parts manufacture into more high tech arenas. The productivity driven job loss was present before the recession. The recession and steel tariffs accelerated the process.

The economy is undergoing structural change with structural job loss and creation. This view is validated by the study of Groshen and Potter.

http://www.newyorkfed.org/research/current_issues/ci9-8.html

They determined that the structural job loss during the current recession is much greater than in the 70s and 80s. The Fed believes structural job loss to be prevalent and therefore job recovery will take much longer than if companies eliminated workers during the downturn and plan on hiring them back. This also agrees with Kevin Phillip's observations on past bubbles that the sector causing the bubble is not usually the one that leads the recovery. Since bubbles are overinvestment, it follows that the job loss is structural (unless conditions change or another bubble reemerges).

This administration has given the most support to old line oil and gas businesses. These are mature businesses that are not engines of job creation. To someone with the parochial experience of George W Bush, creating an oil boom would be a good way to boost the economy. This is great for West Texas but is not a model that works for the rest of the country.

This administration has not effectively nurtured high tech or supported emering areas of the economy. From stem cell research to lack of support for fossil fuel alternatives to eliminating federal technology programs, this administration is not looking forward. From where we sit in the MIdwest, the signs of erosion of job loss are not yet apparent in the near term. The emergence of a new manufacturing sector is one or more years away and maybe longer given the lack of appreciation of the problems of the Midwest by the Federal government.

Make that "ignorati?". Oops, ignorat me.

Is it possible that the Fed concern over deflation is a cover for doing absolutely nothing that could disturb the re-election prospects of George W. Bush.? The Bush family evidently blames Greenspan for H.W.'s defeat, and I am sure he is not anxious to repeat. With my property taxes and insurance premiums taking their biggest jumps ever, it is hard not to feel that current interest rate policy is just politics.

He who has a thousand friends has not a friend to spare,And he who has one enemy will meet him everywhere.

What's on your mind, if you will allow the overstatement?