I think you'll be surprised when you pull up the 10yr real yield vs inflation expectations. Virtually the entire move in bond yields has come at the expense of the real yield component. 10yr real yield is now -.15% while the 10yr inflation expectation is a relatively "normal" 2.25%. Isn't the bond market saying we have a major growth problem that is separate from an inflation problem?
I think if Scott Sumner were here, he would say that the markets see the Fed tightening policy, with all of the impact of the tightening occurring in real GDP.
A more conventional macro story would be that the markets see the eurozone crisis as lowering the growth outlook for the U.S. Also, a conventional macro story would say that the aggregate supply curve should be fairly horizontal given how far we are from full employment. Therefore, any adverse economic event should have a relatively large effect in reducing real output and a relatively small effect in reducing inflation.
Should I be trying to tell a PSST story? I am not inclined to do so, because I don't think that market expectations are based on the PSST model.
I am in favor of expansionary monetary policy until we can sort out what is going on. If what is going on is almost entirely structural unemployment, then inflation will be at least as high as market projections, and probably higher, and we should stop the expansion. Otherwise, the expansion may do some good.
Am I worried about inflation getting out of control? Yes, but because of loose fiscal policy, not loose monetary policy. My line these days as that we have Progressive fiscal policy and Tea Party monetary policy, and I wish it were the other way around.