Another Ugly Regression, Plus Inflation and Interest Rates or Something

Another nail the coffin of of the myth that loose monetary policy means low interest rates. Either monetary expansion means higher nominal interest rates or lower inflation, because these two variables are definitely correlated. And I'm pretty sure printing money does not cause deflation. This is the 10 year rate on Treasuries run against annual inflation.

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.

Austerity Might be Expansionary in the Eurozone

Or at least not contractionary. I've been thinking about the fiscal situation in Europe, and how Keynesian critics of Eurozone policies advocate that government swear off austerity in favor of spending to boost the economy. According to standard Keynesian theory, when interest rates are up against the zero lower bound, monetary policy has no traction and fiscal policy has no opportunity cost because interest rates don't rise to crowd out private investment spending. As a result, countries like Spain and Italy should keep running budget deficits despite fiscal concerns, to support the fledgeling economy. Here's the problem:

That's the real interest rare on government bonds for Italy and Spain. Real interest rates are very much not zero, at least not in Spain and Italy, the two biggest economies presently in crisis. Nor are interest rates very high. But at an interest rate at anything above zero, public borrowing DOES crowd out private borrowing euro-for-euro. Krugman makes this point all the time, saying that deficit spending for the US economy is only appropriate in a liquidity trap with zero interest rates. But I guess the rules are different in Europe.