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Monday, November 15, 2021

The Great Inflation Scare Of 2021 (Or Not...)

Chart: 5-/5-Year TIPS Breakeven Inflation Rate

We had a blowout CPI print in the United States last week, which I probably should have discussed. Unfortunately for my writing productivity, I had some consulting work going as well as visiting family, so I did not have time to dig.

Since then, large numbers of electrons were spilled online discussing the inflation outlook. As I doubt that I will add any details that are novel at this point, I have decided to bow out of that discussion. Instead, I will just offer a few generic observations.

The first thing to note is that forward breakeven inflation rates (as calculated by the Federal Reserve) have risen since the pandemic lows — but are still not above the levels seen in the early 2010s. (As a technical note, one might be able to fine tune breakeven inflation calculations with access to security-level data. But the Fed H.15 data is perfectly adequate for a big picture chart like the one above.)

We need to use forward inflation since everybody accepts that there will be a run of punchy inflation data over the coming months. How long the “punchiness” lasts is the topic of heated debate. As a non-forecaster, I am staying out of that debate. That said, the TIPS market indicates that the punchiness subsides within 5 years. Say what you want, that is not exactly a secular shift in inflation pricing.

Could technicals influence the forward? Sure. The problem is that the most important technical is the demand for inflation protection by the private sector, which is really only counter-balanced by TIPS supply. If people were really worried about inflation, they would be bidding up protection versus fair value — the breakeven ought to be biased higher versus “true” expectations. If that were the case, then the “true” expectations are not elevated relative to “target” (which is vaguely defined at this point).

So unless we are convinced the market is wrong — and it could be (you pays your money, you takes your chances) — the inflation story is just about the timing of “transitory.” Even without digging into data, it seems clear to me that we need to get the flurry of holiday spending out of the way before we can see what the underlying supply chain status looks like.

The other angle is wage inflation. I think we have seen some unsustainable business models based on the availability of desperate workers, and/or hoodwinking people who were unable to account for depreciation into being “contractors” have finally hit the end of their sustainability. Such business are going to face higher wage costs. It remains to be seen whether this is a one-off shift, or sustains itself.

In any event, I hope to return to my inflation manuscript later this week. My feeling is that it will make sense to hold off finishing the book until after we see the backside of this inflation wave (or not), so if I get the bulk of the text sketched out, I will then let the text rest for some months.

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(c) Brian Romanchuk 2021


  1. So your inflation story is non-predictive? Was Fischer Black right that inflation is just noise? Why can't the Fed insure us each against inflation by paying inflation as interest on a CBDC account to encourage individual savings as prices rise?

    1. I’m not a forecaster. So I don’t predict things.

      Paying people money to compensate for inflation creates a feedback loop that causes inflation to grow faster. (Mainstream economists think higher interest rates slow the economy, but even for them, the interest rate might need to rise faster than inflation.)

    2. 《Paying people money to compensate for inflation creates a feedback loop that causes inflation to grow faster.》

      Is this a forecast?

      Why does inflation matter, if both price makers and takers are inflation-insured? Isn't inflation then plainly revealed as simply a psychological power play? Is indexation the best way to expose the power play and neutralize it, by ensuring real purchasing power stability no matter how high or how fast nominal prices may rise?

    3. Not a forecast - a description of how indexation interacted with inflation in earlier eras (1970s).

      Insuring everyone against inflation is effectively impossible. It will create winners and losers. It will still also be politically toxic.

  2. I am interested in Mosler's (apparent) contention that the widely held premise that higher interest rates are disinflationary/deflationary is wrong -- specifically that it is backwards. Something about governments adding money via the interest rate channel being itself inflationary.

    Do you think he is correct? If so, are you able to explain why or why not?

    I haven't been able to prove him wrong about anything before, so I'm inclined to give him the benefit of the doubt. In this case, though, it seems to me that central banks have proven that they can cause recessions by raising rates (viz. Volker), and aren't recessions disinflationary/deflationary?

    1. Sigh. My previous reply disappeared.

      Although Mosler is the highest profile supporter of that view, it was popular in the pre-Volcker period, and variants show up in post-Keynesian critiques of interest rate policy. If you want more information, that literature would be another source.

      Mosler’s argument is straightforward- higher interest rates increase interest spending. Although governments issue fixed coupon debt, duration is not that long.

      If you look at mainstream economists, they might start talking about “debt spirals.” What exactly is that, other than rising interest costs destabilizing the economy?

      As for the Volcker episode, my argument is that sufficiently rapid hikes will destabilize the private sector and cause a recession. The key is speed, not just a level change. Not sure what Mosler’s response to that is.

  3. Thanks for your thoughtful response, Brian. It's helpful in its own right and as a point of departure for further investigation on my part.


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