What level of inflation do people expect over the next several years? We could look at some surveys to try to answer this question, but nothing beats market measures where participants have some skin in the game. One such method of measuring inflation expectations is to compare how Treasury markets price two types of bonds: “normal” bonds—with a constant nominal interest rate—and “inflation-indexed” bonds—with a yield that includes realized inflation. One can tease out inflation expectations by subtracting the real bond yield from the nominal yield. This is the so-called break-even inflation that we show in the graph above for all available maturities.

The graph shows that these expected inflation rates fan out at particular times, typically downward. And, every time, the shorter maturities seem to have the strongest reactions. This is simple arithmetic. For example, a 10-year expectation also contains the 5-year expectation; and, as long as expectations average out in the long run, the shorter-term expectation will be more variable. An exception would occur if the market expects “normal” inflation in the next five years, but “abnormal” inflation during the five years thereafter. That’s very unlikely to happen, at least in terms of expectations.

How this graph was created: Search for “break-even inflation,” select the series, and click “Add to Graph.” From the “Edit Graph” panel, open the “Format” tab and move the series up or down to order them chronologically in the legend.

Suggested by Christian Zimmermann.

In the previous blog post, we looked at using survey data to measure inflation expectations. Now we consider market-based measures. The graph shows various measures of the breakeven inflation rate, which is computed as the difference in returns of constant-maturity Treasury bills: one being the traditional bill and the other being the inflation-indexed bill. If we look at 10-year Treasury bills, we can evaluate what the markets think the average yearly inflation rate will be over the next 10 years. With such a long horizon, it makes less sense to compare these expectations to realized inflation. But this graph still includes a segment to signal the Fed’s 2% inflation target announced on January 25, 2012, since the purpose of that announcement was to anchor inflation expectations.

How this graph was created: Search for “breakeven inflation” and many series will be shown. Here, we used those with a monthly frequency. For the segment, choose “Add a Series” but select “Trend line” from the pull-down menu. Once that’s added, change the initial date to “2012-01-25” and use “2” for both start and end values.

Suggested by Christian Zimmermann