Have you considered that we are in the midst of an unprecedented 'goods and services" supply shock and that will drive inflation 100x more than interest rates (which haven't shown any correlation to inflation since the 80's)?
> (which haven't shown any correlation to inflation since the 80's)
Side question: how do we calculate that correlation? To clarify, I understand that you can take two sets of observations and calculate rho, etc.
What I'm really curious about is how (or whether) the correlation is adjusted. Suppose there is always some kind of base inflation that doesn't correlate with interest rates; do we have a sense for what the additive effect of changing interest rates does?
Sorry to clarify - you can run any correlation on those two lines (wither lagged or not) and you'll find very little direct relationship, but the more important point is:
By saying interest rates and inflation are not correlated, I meant that both inflation and interest rates were declining to historic lows, which is in direct opposition to the theory that 'raising interest rates reduced inflation.' As you can see on this chart, interest rates aren't even that much lower than they were in the period where we were worried we'd never see inflation ever again.
My main gripe with the current narrative around inflation is 'does it really seem logical that moving from 2.5% to 1.0% 10Y yields is what caused inflation (when going from 7.5% to 2.% had no effect), given all we know about how broken our supply chains have become?'
It was not just the 10Y though. QE + traditional federal reserve cuts affected the whole curve, out to 30 and even longer-dated (non-USG) instruments. Then you had the giant stimulus on top of that. This was about as close to helicopter money as I think the US has ever done. Many other countries adopted similar measures. We are seeing the effects of inflation from each of the above. And now, the Fed is winding down QE and raising interest rates. Stimulus is fading. This all takes time. But yes, I think it is pretty reasonable to assume inflation will go down over the next 12 months.
1) 10Y by far is the most important benchmark used in the US economy. It's the foundational rate for almost all consumer lending including mortgages and widely used as the RFR in discounting cashflows.
2) My gripe with the stimulus argument is 'why is inflation accelerating 12 months after we stopped'? For example, are used cars (a major contributor to current inflation) really going up in price b/c people can afford to pay higher prices, or is it because we are making way fewer new cars? Same story for houses (given that we've chosen to abandon billions of sqft of office space and replace that with at-home offices).
Sure, loose money support isn't helping inflation, but the idea that the solution to our current inflation problem is to decrease demand seems unthoughtful, given the fact that we know we are producing well below our potential (on a global scale).
I actually don't disagree with you that inflation will go down in the next 12 months, but I think it will primarily be on the supply side. At least I hope so.
Regarding point 1. Sure the 10 year matters. A lot.
Regarding point 2, we did not stop stimulating the economy 12 months ago. We are still stimulating the economy with negative real interest rates, a relatively high level of deficit spending, and a large federal reserve balance sheet. The only stimulus we have wound down is the pandemic loans/grants, extra unemployment benefits. We are only starting to unwind the FED balance sheet. And, real interest rates are very negative. These last accommodative measures are occurring in the midst of a fairly good economy (very low unemployment, rising wages, etc). That is why we are seeing inflation accelerating.
Okay, these are all demand issues, and you point to the concomitant supply issues as well. And I agree. The supply issues certainly make it worse.
But here's where we disagree and I encourage you to answer this question:
Are cars/gas/consumer goods/food going up in price because consumers can afford to pay more for them (demand-side) or is it because we are making less of that stuff? I agree it's both, but it appears to be supply WAY more than demand (given how loose monetary policy has been for 20+ years and how unprecedented this supply shock is)
