A frightening figure

by on November 20, 2008 at 7:05 am in Economics | Permalink

Paul Krugman presents a frightening figure. 

The figure [below] shows the real interest rates on corporate bonds, with
the expected rate of inflation from the spread between 20-year TIPS and
20-year Treasury rates. All data monthly, from St. Louis Fed.Corporate_real

I’ve been saying for some time that one of the signs of a credit crunch has got to be rapidly rising real rates – in very recent weeks, that appears to be happening.  The timing suggests to me that this is more of a deflation problem than a banking-credit problem per se but at this point who cares – we can probably all agree it’s more bad news.

Addendum: Greg Mankiw is also troubled by what this figure means.

1 Ted November 20, 2008 at 7:31 am

Why isn’t the answer to deflation simply printing more money?

2 Speedmaster November 20, 2008 at 8:36 am

>> “Paul Krugman presents a frightening figure.”

That statement is true all by itself. 😉

3 Steve November 20, 2008 at 8:53 am

Isn’t the problem not that there is to little money, rather, that there’s too little money being put to work, so to speak? The treasury and Fed have so far pumped an additional $2t into the economy that’s mostly just sitting around. I have little doubt this will continue. I guess I am just surprised no one is concerned about the potential for hyperinflation and the decimation of the dollar in a couple years. Can anyone tell me why I might be crazy?

4 Ted November 20, 2008 at 9:12 am

@8:30 — if what you’re saying is true, then “deflation” isn’t a problem, but a symptom of the problem, so you’re challenging the premise of the question.

I’m asking the people who think deflation is a problem in and of itself, which would seem to include Alex.

5 Massimo GIANNINI November 20, 2008 at 9:14 am

It’s not that frightening, if we consider that:

a) high real interest rates stem from fears of debt repudiation and that such fears may prove self-fulfilling;
b)market trades lower inflation in the short run for higher inflation in the long run;
c) contrary to Walras’ law, which states that the bond market always clears, that is not obviously happening at present;
d) it means less investment projects are financially viable;
e) it reveals the collapse of the marginal efficiency of capital and the rise of liquidity preference (only cash and not highly illiquid financial assets of some corporates…).
When figures are not frightening anymore

6 David November 20, 2008 at 9:24 am

That’s some hockey-stick lookin’ chart right there. Can we see the plot of the inflation correction value? Deflation expectations should show up in that data alone, without including corporate rates. Can we go back earlier than 2004? What’s the 20 year mean real AAA borrowing rate? I bet it’s more than 5%.

7 ZBicyclist November 20, 2008 at 9:59 am

OK, let’s ask another basic, naive question.

If the best thing for business planning is to have stable, predictable policies, then could we imagine policies more likely to disrupt business planning than those adopted by the US government this year?

Bear vs Lehman. Save AIG, but other insurance companies become banks. $600 stimulus checks. Maybe people who hold underwater mortgages will be helped, maybe not. $700 billion to buy securities at auction — no, wait, let’s not hold that auction.

8 bbartlog November 20, 2008 at 10:33 am

high real interest rates stem from fears of debt repudiation and that such fears may prove self-fulfilling;

High real interest rates are not merely a result of the incorporation of risk; they can also reflect the time preference of savers in general. The fact that the Boomers are leaving the workforce and beginning to draw down their retirement savings (and that many more of them will begin to do so in the next ten years) means that the time preference of the American Saver, at least, is undergoing a sea change.

9 David November 20, 2008 at 11:26 am

Yeah, it’s so risky it’s almost 5%.

10 MW November 20, 2008 at 11:46 am

The graph uses the TIPS vs. Treasury spread to account for inflation/deflation. One commenter had the theory that the TIPS spread may underestimate inflation due to the possibility the government, down the line, underestimating inflation to reduce their rate increase.

All the new Fed bonds issued the last few months, by the way, will not seriously affect inflation because they’re likely to just be sitting around in company faults until banks have to repay the Fed with super-low interest. True hyperinflation would be caused by the government monetizing a lot of its costs, which Nouriel Rubini (sp?) has said would not be worth the short-term stimulus to the economy.

Interesting times we live in.

11 mickslam November 20, 2008 at 12:19 pm

I concur with the lack of income being the problem. When you look at MEW over the last few years and realize that it has gone from being a MEW to being something that needs to be replaced. It is a huge problem that essentially all of our growth was financed by income gains at the top and MEW for the middle class. We need to rectify this problem and stimulate the economy.

There is a simple solution that is easier than issuing a debit card that disappears at the end of the month. Suspend payroll taxes and have the treasury pay for those taxes for the next 6 months.

Doing this is about $20B a week in stimulus, so 20 weeks is only about $400B in stimulus. We could do if for a year for about a trillion dollars. It would then be spent by people and divert future resources into improving the low to middle-end consumer part of our economy. The people that this would largely impact are people that live paycheck to paycheck. They won’t save it- they will spend it either to reduce their existing debt or to upgrade something within their lives.

Trickle up economics.

12 Anonymous November 20, 2008 at 12:33 pm

“I want to encourage our entrepreneurs and our most productive workers. I want to bring out the creative genious of a free and bold people. They are the great ones who built our country. They are the ones who will rebuild it, now and in the future.”

The creative genious has been encouraged over the last 8 years with cheap money and tax cuts . . . it came up with a smorg of CDS, SIV, CDO etc etc to leverage the economy to the hilt with little transparency and unbridled “enthusiasm” that way too many bought into (school boards “gambling” on derivatives GMAB!). The consumer consumed to the max on Mcmansions that made no economic sense (prices @ 10x income!) and all kinds of other doodads and thingamajings.

Time for a rest, re-evaluation, re-pricing here. Not re-ignition.

13 Robert Ayers November 20, 2008 at 3:20 pm

Another way to look at the figure is this:
“The markets do not believe current credit ratings. They are pricing AAA bonds the way that they used to price BAA bonds.”

14 Vic November 20, 2008 at 4:34 pm

Mike Shedlock (one of the top 3 most read economics blogs on the web) has been warning about this since 2006:

Sadly, he’s an Austrian economist, so clearly he doesn’t know what he’s talking about, right Tyler?

15 Alan Brown November 20, 2008 at 5:51 pm

Exactly. This is deflation. And you just need to look at the price of gold to see that:


A return to pegging the value of a dollar to gold or some set of stable commodities will end the inflation/deflation cycle.

Inflation and deflation are not just measured by the CPI. The CPI is a trailing indicator, especially when manufacturing and labor inflation are suppressed by global competition.

16 y81 November 20, 2008 at 8:54 pm

Agreeing with several of the commentators, all the work in this graph is done by the “expected inflation rate as measured by the TIPS/Treasury spread.” There’s a chart on page A17 of today’s Journal of the TIPS/Treasury spread which matches this chart exactly. Given the dislocations in the bond market recently, most of which no one understands (e.g., the 30 year swap rate is below the Treasury rate), I would hesitate to draw any firm conclusions from Krugman’s chart.

17 Ricardo November 21, 2008 at 3:50 am

Exactly. This is deflation. And you just need to look at the price of gold to see that:


Inflation and deflation are not just measured by the CPI. The CPI is a trailing indicator, especially when manufacturing and labor inflation are suppressed by global competition.

Until fairly recently, it wasn’t difficult to find people arguing that the U.S. is in the midst of a South American-style hyperinflation/depreciation due to rising gold and commodity prices. Indeed, if you look at gold prices around May of this year, they had increased over 30% from the price of May ’07. Now that gold (and oil) prices have collapsed, it’s “proof” that we are in the midst of deflation. Sorry, but it’s time to look for other forward-looking indicators of inflation — commodity prices are much too volatile in the short-run to provide guidance. If you had actually bet money on inflation or dollar depreciation on the basis of high gold prices several months ago, you would be in deep, deep trouble right now.

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