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Expected Inflation in an Era of Large Budget Deficits
Sanjay Paul, Kevin Miller

Last modified: 2011-09-08


Developed countries have emerged from the 2008-09 global recession
with large budget deficits. The corresponding increase in national
debt has led to fears that governments will soon face higher interest
rates and rising inflation. The experience of Ireland, Greece and
Spain illustrate the bleak disfavor with which bond markets eye
unsustainable government imbalances, and even the U.S., with its
growing debt, may have to contend with higher interest rates and
pernicious rates of inflation. In this paper we seek to analyze recent
developments in public finances, interest rates and price levels in
order to establish the determinants of inflation. We consider, in
particular, the difference between the interest rates on 10-year
Treasuries and the 10-year Treasury Inflation Protected securities as
an indicator of expected inflation. We contrast this measure with
other variables that might also explain expected inflation, including
government debt, money supply and the price of gold.