The Term Structure Of Expected Inflation

The term structure of expected inflation is key to assessing the credibility of monetary policy, to examining how borrowing decisions of households and firms respond to shifts in real costs of debt, and to evaluating the expected inflation response to monetary policy actions. Unfortunately, direct observations on market expectations of inflation are limited.Surveys of forecasts provide one source of direct information on expectations but are infrequently used, partly due to the incomplete sampling design of available surveys: Only short time series are available for surveys that sample at quarterly frequencies or higher. In addition, lengthy time series are available only for surveys of short-horizon forecasts, generally two-or four-quarter outlooks, and are often collected only at semiannual intervals.These limitations lead researchers to alternative proxies for inflation expectations. Some analyses use forecasts from econometric models. Others take theoretical specifications of the nominal term structure, impose strong restrictions on the long-run properties of real rates or inflation, and extract an estimate of the term structure of expected inflation. In many instances, these proxies do not resemble the expectations revealed in surveys, calling into question inferences drawn from these proxies regarding policy credibility, investment decision-making, and monetary policy transmission.This paper uses survey data on short-horizon CPI expectations from the Livingston Survey to construct a 50-year history of monthly ex ante measures of the term structure of expected inflation for the United States. The estimation uses a time-varying forecast methodology that assumes the unobserved cross-section of expectations formulated in a given period is consistent with recent inflation and available survey data on expectations. Estimates of the time-varying term structures of inflation appear to be relatively robust to the pattern of missing observations in historical survey data. For instance, term structures constructed only on the basis of short-horizon expectations are relatively close to those based on longer-horizon expectations, when the latter are available.