Friday, October 17, 2014

Worried about inflation?

There are lots of things to worry about these days.  You could worry about Ebola, the Middle East situation, who will control the U.S. Senate, etc.  In addition, there is a group of folks who have continually warned that inflation is just around the corner as a result of Federal Reserve policies that aim at keeping interest rates low.

If inflation were to break out, the Federal Reserve would react, possibly slowing or even reversing the economic recovery since the Great Recession.  That development would do bad things to the California state budget and, therefore, the UC budget.  In addition, the UC pension plan has only a partial and limited inflation adjustment built into it.  Pay of active faculty - already behind the comparison-8 - might also be eroded.

However, there is no sign of inflation accelerating currently.  And in fact financial markets are not anticipating a future of inflation as the chart above shows.  The U.S. Treasury issues conventional bonds and bonds which are indexed to inflation.  The gap or spread in the yield between the two is a kind of forecast of inflation.  As you can see from the chart above, there is no indication of an expectation of inflation in the near term, or even in the long run.

Of course, financial markets can be wrong, as the Great Recession itself amply demonstrated.  But the same folks who keep warning of inflation paradoxically tend to be those who are market believers.  Yet in this case, they seem to ignore what the markets are saying. Of course, the risk of inflation is not zero; that's why folks buy inflation-adjusted Treasury securities.  But for the moment, why not worry about Ebola, the Middle East, and who will control the Senate instead?

Or don't worry at all:

No comments: