Bond Economics

Inflation Outlook: Was I Too Pessimistic?

2026-05-07T09:53:00.004-04:00

Although I have not been attempting to do economic forecasts, the current environment is surprising to me, at least with regards to inflation. The above figure shows the 5-year breakeven inflation rate as based on the U.S. inflation-indexed bond (TIPS) market.

The 5-year breakeven inflation rate is the 5-year conventional bond rate (“nominal yield”) minus the quoted yield (“real yield”) on a 5-year inflation-indexed bond. This difference (shown above) is the rate of inflation required over the next 5 years for the two bonds to have the same rate of return. (Hence, the TIPS breaks even with the conventional bond.) The above series are from the Federal Reserve H.15 Report, which are fitted yields, and so there can be gaps between the measure above and better-measured breakeven rates for particular bonds. However, the gap between this measure and “physical bonds” are unlikely to be too large at the 5-year tenor.

Although the breakeven rate has risen slightly, it is nowhere near the levels seen post-pandemic and the (renewed) Russian invasion of Ukraine. Of course, it is above the levels of the 2010s, where the economy was mired in excess capacity. The current disruptions represent a one-time shock, so the inflationary impact should mainly show up in shorter tenors like the 5-year. Since we have little basis to make inflation point forecasts four years out (for example), we need to assume that inflation will revert to some form of long-term average, which something like a 30-year breakeven should represent.

It may be that markets are too complacent about the situation in the Persian Gulf. At the time of writing, there has been another breakout of peace optimism. That said, it looks like Asia and Africa are facing the brunt of the oil price shock. Their demand is being destroyed the fastest, which buffers the rest of the world.

Nevertheless, my concern was not just oil prices, but the supply chain disruptions that downstream of the cutting of commodity flows out of the Gulf. Those disruptions would take months to show up. However, these other price shocks will be focussed on physical production, and so will have less effects on services-heavy economies.

My writing has faced a few recent distractions, and it looks like I may be travelling some time soon. It is likely that my output will be focussed on getting my inflation book finalised. It was in fairly good shape, although I was updating charts, and adjusting text to account for the economic convulsions courtesy of the White House.

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Book Comments: "The Deficit Delusion"

2026-04-30T09:17:00.000-04:00

A new book at my library caught my eye — “The Deficit Delusion: Why Everything Left, Right, and the Supply Side Tells You About the National Debt is Wrong,” by John Tamny. I was not familiar with Tamny, but he is Editor of the RealClearMarkets website. I would not describe this article as a review, rather I just want to outline what I see as major points in the book (which I am not too convinced about).

The angle appears interesting in that we have a pro-free markets person arguing that we should not need to worry about the American government defaulting on its debt. Given that there is a Republican in the White House, it is perhaps timely for free marketeers to pivot away from debt worrying. The author has fun skewering the professional government debt worryers that dominate “serious” fiscal analysis in the United States.

Too Much Reliance On Market Efficiency?

The following quote (from page 19) is a key argument of the book:

How, if the United State is bankrupt, can it borrow so much now, and according to the CBO, well into the future? Hopefully the answer to this question is a little bit clearer at this point. The answer is that — love or hate government borrowing — the United States is not bankrupt. Quite the opposite. Since exceedingly few throw away money or disdain potential returns, there’s no way the United States could keep borrowing trillions a year now and into the future if it were bankrupt. Sorry, but there’s not nearly enough dumb money in the world to fund all the United States’ borrowing.

This is one of the few times that I am aware of a pro-free market person pointing out that the same people who argue that markets are efficient are also prone to arguing that government bond markets are wildly mispricing the risk of default.

(Note that there might be better expressions of his this view in the book, but the text has a tendency repeat the same points, so I picked the first example I found when I started writing.)

Although I do not disagree with the sentiment, it faces an obvious rebuttal. Historically, the American government listened to the debt doomsayers, and so it did not push the bounds of fiscal propriety in peacetime. (In World War II and its aftermath, the U.S. government used “financial repression” and rationing to allow government war finance to function.) As financial disclaimers say, past performance does not guarantee future results.

The argument also ignores the obvious reality that some governments borrowed for extended periods peacefully then succumbed to financial crises. (These crises tend to be tied to currency pegs, which is a point that proponents of Modern Monetary Theory (MMT) would highlight.)

Equity Finance

The book is filled with an inappropriately large discussion of the financing of start-up firms. These anecdotes allow the author to offer flowing tributes to the entrepreneurial genius of rich people, but do not tell us much about government finance.

Tamny’s point can be summarised that the rate of interest does not matter to entrepreneurs at start-ups, as their businesses are so risky that they can only get equity finance. Since most large firms were originally small, one could try to argue that equity finance is the only thing that matters in capitalism. since it is at the root of growth.

However, even cursory knowledge of the national accounts tells us that equity financing is not relatively important within the national economy. (Equity market capitalisations are large — but the amount of financing raised is typically a very small proportion of market caps.) The modern favouring of stock buybacks means that net equity financing is typically negative. Meanwhile, established firms and the household mortgage market have extremely large gross and net debt financing flows.

Start-ups might be largely decoupled from interest rate markets, but they are small, and thus have a small economic weight (even if they catch the imagination of the financial press). So we cannot use their experience to say much about the effects of interest rates on the business cycle.

Pre-Keynesian Economics

The reason why I decided to not position this article as a review is that the theoretical basis of the discussions appear to be a variant of pre-Keynesian economics. Rather than trying to find compact quotes, I will just paraphrase the arguments as best I can.

The argument is made that only supply matters — demand (which are treated as equivalent to “desires”) is unlimited. This would be a plausible way of viewing the economy if production was always at full capacity, so we have a fixed real output that has to be allocated amongst “agents” in the economy.

A related point is that money is seen as being “real,” as exchange is always “goods for goods.” (Think of “money” as being gold — which needs to be mined and refined, as opposed to electronic entries on banks’ computers.) The U.S. dollar is real money because of the success of the American economy (and the ability of the American Federal Government to tax that ever-growing economy), while Russia and other dubious states like North Korea allegedly use American dollars because their economic prospects stink. (Business people supposedly do, but what about the rest of the economy?)

Although real goods matter, my argument is that we cannot ignore monetary constraints. Wages are paid in dollars, sales are made in dollars, and debt contracts are denominated in dollars. Dysfunctional monetary situations can happen independently of what is happening to real production. Given the gulf between my views and Tamny’s on this basic theoretical point, it would take an inordinate amount of my readers’ time to cover his theories in detail.

MMT Gets Mentioned (Yay?)

One reason that the book caught my eye was its title. A book entitled “The Deficit Delusion” released five years after Stephanie Kelton’s best-selling “The Deficit Myth.” I assumed that there had to be a call back to Kelton’s book, but nope. That said, MMT gets mentioned, but the previous theoretical issues shows up. He summarises the MMT position relatively well, but he dismisses it due to his views about money. That is, if you believe that money is a real object, that is incompatible with the MMT/Functional Finance view that the value of money is driven by convention and existing monetary contractual obligations, not real constraints. Even though governments now try to keep inflation at a target level, that does not guarantee that money can be treated as a real commodity in analysis.

Concluding Remarks

The book is written at an introductory level, which may benefit some readers. The problem is that the author is so busy giving us anecdotes about how rich people became rich that he failed to cover even the basic objections to his theory that the American Treasury market is always efficiently prices and there is no prospect of risk-taking preferences changing.

That said, free marketeers who want to have any shred of intellectual integrity might want to start changing their thinking along the lines suggested by this book. Screaming that the Treasury market is going to explode in a ball of flames due to the deficit when Obama is President and then wrack up record deficits under President Trump and arguing that everything is going according to plan is obviously incoherent. That said, I see little hope for intellectual coherence to come back into fashion any time soon.

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Canadian Inflation Comments

2026-04-20T16:42:00.000-04:00

So far, the gasoline price shock in Canada has not been as bad as what happened after the pandemic, but I am not incredibly optimistic about the medium-term outlook. The above figure is the national average cost for unleaded gasoline (at self-service stations if you want to get even more specific), but the data ends in March, so it is missing the price rise since then. In my neck of the woods in the Greater Montreal Area, the pump price has been around $2 per litre, although Montreal is normally higher than the national average series shown above.

The Carney government announced a temporary suspension of the excise tax on gasoline on April 14th, which dropped the price by about 11 cents per litre. This generated a lot of flak from economists, but I doubt that it will matter that much if the situation does not improve in the Middle East.

The Canadian CPI numbers for March were released today, and core inflation remains stuck at a level above the 2% target. This starting point makes it hard for the Bank of Canada to be too complacent in the face of commodity prices.

The diplomatic situation around the Strait of Hormuz seems muddled, but it is clear that that full traffic flow will not resume immediately. This means that oil and gas fields will be shut in for an extended period, and restarting them will take time. As such, it is clear that regions that are dependent upon the commodity flows from the Gulf are going to be hit hard. Canada is not directly affected, but it will see a lagged effect of slowing growth elsewhere. At the same time, the signals from the White House remain belligerent towards Canada, and an attack on the Canada/Mexico/United States trade pact may occur once attention is drawn again to that topic.

The Bank of Canada’s next scheduled policy rate announcement is April 29th, and I see no reason for them to switch from their last assessment that growth risks are skewed to the downside, while inflation risks are to the upside. In the absence of clear data, it seems unlikely that they will move in the near run.

Fiscal Policy?

Although the gasoline excise tax cut was unpopular with economists, it is still a limited measure that targets the fastest rising price in the economy. My uneducated guess is that fiscal policy is going to deviate much from already announced plans. There are currently no measurable growth risks that will cause panic loosening of policy. A global recession due to the commodity shock would take time to hit Canada (and as a commodity exporter, some sectors of the economy will benefit from higher commodity prices). A complete rupture of free trade with the United States is a scenario that might provoke a more rapid fiscal reaction.

Without accommodative fiscal policy, the commodity price hike will tend to squeeze consumers, and so there might not be second-round price effects. (Although Canadian commodity exports would benefit, the employment in primary industries is not large enough greatly push the overall labour market.)

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