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Disagreement about inflation and the yield curve

Author

Listed:
  • Paul Ehling

    (BI norwegian business school)

  • Michael Gallmeyer

    (University of Virginia)

  • Christian Heyerdahl-Larsen

    (London business school)

  • Philipp Illeditsch

    (University of Pennsylvania)

Abstract

We show theoretically that inflation disagreement drives a wedge between real and nominal yields and raises their levels and volatilities. We demonstrate empirically that an inflation disagreement increase of one standard deviation raises real and nominal yields and their volatilities, break-even inflation, and the inflation risk premium by at least 30% of their respective standard deviations. Inflation disagreement is positively related to consumers’ cross-sectional consumption growth volatility and trading in bonds, interest rate futures, and inflation swaps. Calibrating the model to disagreement, inflation, and yield data reproduces the economically significant impact of inflation disagreement on real and nominal yield curves.

Suggested Citation

  • Paul Ehling & Michael Gallmeyer & Christian Heyerdahl-Larsen & Philipp Illeditsch, 2015. "Disagreement about inflation and the yield curve," Working Papers 1532, Banco de España.
    • Handle: RePEc:bde:wpaper:1532
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    References listed on IDEAS

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    More about this item

    Keywords

    Inflation disagreement; relative entropy; real and nominal yields; yield volatilities; break-even inflation; inflation risk premium; cross-sectional consumption growth volatility; trading on inflation;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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