Saturday, June 23, 2012

Are Inflation Hawks Smarter than the Bond Market?

Inflation Hawks (think Ron Paul, Paul Ryan, Paul the Apostle)  have been saying for the past several years (since 2008 if memory serves) that runaway inflation is just around the corner, and hyperinflation is a likely possibility. To corroborate their predictions, they cite data like this:

Thats the monetary base, and yes it explodes round about 2008 before leveling off recently. This increase in the base, they say, will in short order lead to massive growth in the broader money aggregates; working with a short-run simplifeid QTOM, that gives you a surefire diagnosis of future inflation.

The bond market disagrees (and so can you!). "It" seems to know that aggregate demand is driven by nominal spending, and the extent to which nominal spending splits between more real GDP and more inflation is determined by the elasticicity of the short run aggreate supply curve. Given recent slow growth of nominal GDP (its increased about 6% total since 2007), and persisitent capacity underutilization and unemployment that are likely to lead to an elastic aggregate supply curve, inflation of any severity just not a likely scenario. I know it, the bond market knows it, and you should know it too. As evidence, here's a chart showing the yield on indexed and non-indexed T- Securities. The difference between the two is the amount of expected inflation.

* Note the consistency.

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