Paul Krugman: PPP and Japanese Inflation Expectations: Noted

Paul Krugman: PPP and Japanese Inflation Expectations:

I’m doing a bit of work on Abenomics.... One thing I discovered along the way is that nobody much likes any of the existing measures of inflation expectations....

Mandel and Barnes, building off work by Goldman Sachs... use inflation expectations inferred from US TIPS, then adjust by the forward exchange rate.... It’s a clever idea, but... real exchange rates are mean-reverting (pdf), and you should take that into account.... So here’s what I did: I took the implied 10-year breakeven inflation rate from US TIPS, minus the 10-year interest rate differential, plus the real appreciation Japan would experience if the real exchange rate against the dollar 10 years from now were to return to its level in January 2010....

Here’s the result. I have my doubts about the apparent decline in recent months. It’s being driven not by events in Japan but by the taper scare, which drove up US rates.... The main point, however, is that this measure does suggest a substantial rise in expected inflation since Abenomics began, which is good news.