WITH stockmarkets tumbling and the oil price below $30,some economists are once again worrying approximately global deflationary pressure. Low inflation can be toxic for economies when interest rates are also low (see a previous Explains). One warning light that is flashing red in America is market expectations of inflation, which absorb plummeted to lows not seen since the financial crisis. How are market inflation expectations measured, and why do they matter?There are two popular measures of how much inflation markets expect. One is the inequity between the return investors execute on government bonds which are indexed to rise with inflation,and the return they execute on bonds with no such protection. This gap—known as the treasury inflation protected securities (TIPS) spread—should rise and fall with investors’ reckoning of how much inflation is in the pipeline. nowadays, the five-year TIPS spread stands at around 1.1%well below the Fed’s 2% inflation target. The second method relies on the market for interest-rate swaps. These are contracts...
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Source: economist.com