This continued period of low headline inflation is a concern, in part, because it could lead to significantly lower inflation expectations. If this drop in inflation expectations were to occur, it would, in turn, tend to depress future inflation. Evidence on the inflation expectations front suggests some cause for concern. In particular, market-based measures of longer-term inflation compensation derived from nominal and inflation-indexed Treasury securities have fallen to very low levels. In addition, some survey measures of household inflation expectations have recently moved lower. 2  BIS central bankers’ speeches  With respect to the market-based measures, there are some reasons to discount the decline. Several term structure models, including those estimated at the New York Fed, attribute most of this decline to a decrease in term premiums – what investors demand for insurance against inflation risks – and not to a decrease in long-term inflation expectations. These models suggest that, over the indicated horizon, investors anticipate that low growth will occur along with low inflation. Still, given the extent to which inflation compensation has fallen since mid2014, I believe that it is prudent to consider the possibility that longer-term inflation expectations of market participants may have declined somewhat. What I find more concerning is the decline in some household survey measures of longer-term inflation expectations.
But the present magnitude of the U.S. external imbalance seems difficult to reconcile with plausible estimates of future productivity and potential output growth. The demographic shifts underway in the major economies seem to have contributed to an increase in demand for longer-dated fixed income assets to fund growing pension liabilities, and these shifts have been reinforced by actual and anticipated changes in the regulations that affect pension fund managers. These changes may have operated to push up the price and lower the yield on longer maturity bonds, but the effect of these changes seems likely to be small in comparison to the changes in the behavior of forward interest rates. The rise in the current account surplus that is the counterpart to the U.S. deficit has focused much attention on the rise in measured savings relative to investment that has emerged in many economies. But the implications of this are ambiguous. If the rise in so-called excess savings principally reflected  2  BIS Review 18/2006  concern about future economic opportunities and weak investment demand, then this might imply a decline in future real interest rates. But the pessimism implied by this view is hard to reconcile with the relatively robust pattern of investment growth, particularly in those countries with some of the larger external surpluses. It is hard to reconcile with the fact that growth in aggregate demand globally has been reasonably strong through this recent period of relatively low forward interest rates.