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Yield curve forecasts of inflation: a cautionary tale

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  • Stephen R. Blough

Abstract

Long-term interest rates that are unusually high relative to shortterm interest rates are often seen to reflect market expectations of increasing inflation. Given that the term structure of interest rates (also called the yield curve) reacts to inflation expectations, does it do so in a reasonable manner? Does the term structure embody inflation forecasts that bear a sensible relationship to the iiaflation that in fact occurs? ; This article reviews the theoretical link between the term structure and inflation expectations, and then it provides empirical evidence on the link in light of the theory. It finds little evidence of a link between the term structure and future inflation at the horizon chosen for study, the relationship between one- and two-year interest rates and the one-year ahead change in the one-year inflation.

Suggested Citation

  • Stephen R. Blough, 1994. "Yield curve forecasts of inflation: a cautionary tale," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 3-16.
    • Handle: RePEc:fip:fedbne:y:1994:i:may:p:3-16
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    Cited by:

    1. Seppälä, Juha, 2000. "The term structure of real interest rates : Theory and evidence form UK index-linked bonds," Research Discussion Papers 22/2000, Bank of Finland.
    2. Yash P. Mehra, 1997. "The bond rate and actual future inflation," Working Paper 97-03, Federal Reserve Bank of Richmond.
    3. Christopher Ragan, "undated". "Deriving Agents' Inflation Forecasts from the Term Structure of Interest Rates," Staff Working Papers 95-1, Bank of Canada.
    4. repec:zbw:bofrdp:2006_025 is not listed on IDEAS
    5. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
    6. Sharon Kozicki, 2001. "Why do central banks monitor so many inflation indicators?," Economic Review, Federal Reserve Bank of Kansas City, vol. 86(Q III), pages 5-42.
    7. Ravenna, Federico & Seppälä, Juha, 2006. "Monetary policy and rejections of the expectations hypothesis," Bank of Finland Research Discussion Papers 25/2006, Bank of Finland.
    8. repec:zbw:bofrdp:2000_022 is not listed on IDEAS
    9. Crockett, Jean A., 1998. "Rational expectations, inflation and the nominal interest rate," Journal of Econometrics, Elsevier, vol. 83(1-2), pages 349-363.
    10. Ravenna, Federico & Seppälä, Juha, 2006. "Monetary policy and rejections of the expectations hypothesis," Research Discussion Papers 25/2006, Bank of Finland.
    11. Seppala, Juha, 2004. "The term structure of real interest rates: theory and evidence from UK index-linked bonds," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1509-1549, October.
    12. Apaitan, Tosapol & Disyatat, Piti & Manopimoke, Pym, 2020. "Thai inflation dynamics: A view from disaggregated price data," Economic Modelling, Elsevier, vol. 84(C), pages 117-134.
    13. Sharon Kozicki, 1997. "Predicting real growth and inflation with the yield spread," Economic Review, Federal Reserve Bank of Kansas City, vol. 82(Q IV), pages 39-57.

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    Keywords

    Inflation (Finance); Interest rates;

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