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What’s going on with expectations?

June 26, 2012

Recently, the Fed has decided to allow aggregate demand expectations to decline. Unfortunately, NGDP numbers only go up to 1/1/2012 as of the time of this writing, so I can’t see if the trend is down. Since 2010, it has been remarkably stable, albeit too low.

NGDP

Both consumer and producer prices have seen lower inflation lately, although it seems to be mostly driven by oil prices (see chart below). Lower oil prices are a good thing because the U.S. imports a lot of oil, so it’s not only a positive supply shock, but also a terms of trade shock. This should be all good news: stable NGDP trend, lower inflation, low oil prices, but something is odd about expectations.

Consumer Price Index: All Items

Consumer Price Index: No Food or Energy

Producer Price Index: All Items

Producer Price Index: No Food or Energy


Source.

1 Year Inflation Expectations

5 Year Inflation Expectations

Historic Expectations of Long Term Bonds

Expectations have become unanchored. Markets do not trust the Fed to keep the economy stable, and recently they have expected the Fed to reduce aggregate demand substantially. This is most distressing. Expectations should be up. The stock market should be doing fine. Profits are high, NGDP seems to have stabilized.

Unemployment has basically not changed at all since the worst part of the crisis, and is especially bad for recent college grads. I just don’t get why the Fed would hit the brakes, and for that matter, why the market would expect them to.

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