Wednesday, April 10, 2013

It's (Probably) Not Inflation Expectations...

That are driving up interest rates in Spain and Italy. As a card-carrying monetarist, one of my maxims is that nominal interest rates are driven by inflation expectations. This presents a quandry as far as the eurozone goes, because nominal interest rates are high and inflation low. Presumably, bond investors in Spain and Italy should not be expected substantial inflation anytime soon, unless they are anticipating a departure from the euro and a subsequent devaluation.
Either that is the case, or the equilibrium real cost of borrowing the these two major European economies has gone up. And whereas in the past I have demonstrated that interest rates on U.S. debt mostly rise and fall with inflation, it may not be the case with Spain and Italy.

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