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Do investors expect too much from Bernanke?

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Financial markets seem convinced that quantitative easing will be highly effective at solving at least one problem: inflation running well below the Fed’s 2-percent-or-so target. The chart above shows the difference between interest rates on 5-year inflation-protected bonds (which are now negative) and rates on unprotected bonds; implicitly, the market forecast of inflation over the next five years has risen half a point. But I really don’t understand this. Granted that QE2 will probably have some positive effect, hopefully bigger than analysis based on the debt-maturity equivalence suggests. Still, the prospect remains that we’ll face multiple years of high unemployment — or, if you prefer, a protracted large output gap (PLOG). And history is clear on what that means: declining inflation.

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