Since the end of the Great Recession, market-based measures of long-run inflation expectations have seemed highly correlated with the spot price of oil. To see what we mean, consider the FRED graph above, where we plot the price of oil (West Texas Intermediate) against the 5-year, 5-year forward expected inflation rate. This measure of expected inflation is calculated using measured yield differentials between nominal and inflation-protected Treasury securities (TIPs) at 10- and 5-year maturities. (To further highlight the correlation, consider the scatter plot of the same data below.)
The 5-year, 5-year forward rate is meant to capture the bond market’s 5-year average forecast of inflation beginning 5 years from now. In this way, anything expected to affect the economy over the next 5 years should not factor prominently in a long-run forecast made 5 years from now. But then, why should the contemporaneous price of oil correlate so highly with the
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