The Great Inflation Scare of 2010

As previously noted, the recent rise in 10-year Treasury rates has raised concerns about inflation in some quarters. Paul Krugman writes of the rise in the term spread:

What the large spread now tells us is that the US economy is in the dumps now, but that investors see a reasonably good chance of a strong recovery in the not-too-distant future. That’s good news, not bad news.

More broadly, on the risks-of-default thing: surely if investors were growing worried about US ability to honor its debts, they would be worrying about a breakout of inflation as well as or instead of default per se. But we can track that by comparing interest rates on ordinary bonds and inflation-protected bonds. What we see is that from 3/17 to 3/30 — the period that inspired all those recent scare stories — the nominal interest rate on 10-year bonds rose by 26 basis points; the real rate rose by 28 basis points. So expected inflation actually declined, marginally.

Here's the data that backs him up. The red line is expected inflation as measured by the difference between yields on nominal 10-year Treasuries and inflation-indexed Treasuries. It went up a bit (5 basis points) last week, and since then has fallen about half way back down. It has been fairly stable throughout the month. The blue line is the credit spread - the difference between yields on Baa corporate bonds and 10-year Treasuries. It's been falling all month, and in fact fell a tad during last week's rise in the term spread. This suggests that what happened last week was a move out of Treasuries and into risky assets (simultaneous with a move from short-term to long-term securities), which is exactly what we want to have happen.

By the way, Krugman said nothing different from what I wrote in a post a couple of days before. Yet his mots justes inspire Brad DeLong to repeat his mantra:

Once again, the two rules:

1. Paul Krugman is right.
2. If you think Paul Krugman is wrong, refer to rule #1.

I definitely need to get me one of them Nobel thingies.