Krugman estimates a Phillips curve thus solidifying my belief that he, along with Kling, doesn’t know modern macro.
There is no structural relationship between output gaps and inflation. The correlation he estimates means nothing. Nothing. Certainly, you can’t, as he does, read off the chart future inflation rates using estimates of output gaps.
Expectations of inflation matter. We don’t know what expectations of inflation are because being expectations they’re in people’s heads. We can get some hints at what expectations are by looking at markets where people bet on future inflation rates ((Annoyingly, the Fed has stopped publishing statistics that translate the prices in these markets to a measure of inflation expectations. Not sure why they’ve postponed this analysis when it would be really, really nice to have it. Krugman, strangely given this recent post, looked at similar data a few weeks ago. He, of course, declared inflation expectations to be tanking, threating deflation. The problem with just comparing the TIPS rate and the treasury rate, like Krugman does, is there’s a liquidity premium. People will bid up the price of a bond that has a thiner market. Those two markets may have different premiums or the premium might swamp out differences in these rates due to inflation expectations. Greg Mankiw says using TIPS data to understand deflationary expectations doesn’t work because the payoffs on those bonds is asymmetrical. Anyway, while I suspect TIPS data is a squirrelly measure of expectations, I wish someone could explain this stuff to me.)). Another source of information about expectations is surveys of inflation forecasters (industry economists and the like). A recent paper by Mankiw, Reis and Wolfers looks at these data over the last few generations. Also, here’s some measures the Fed uses to get a sense for what people expect to happen to the price level. Notice “real” interest rates are positive which isn’t consistent with a Krugman’s definition of a liquidity trap (or what I call a weak liquidity trap).
Anyway, there’s no reason to think looking at historical inflation rates will tell us anything about what people expect future inflation to be. I think this is doubly so given the break down of traditional monetary policy. People won’t necessarily believe the Fed has as much control over inflation as they usually do. This goes for profession forecasters, too. They may not be so good at their job these days.