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The TIPS Yield Curve and Inflation Compensation

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  • Refet S. G�rkaynak
  • Brian Sack
  • Jonathan H. Wright
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    Abstract

    For over ten years, the Treasury has issued index-linked debt. This paper describes the methodology for fitting a smoothed yield curve to these securities that is used at the Federal Reserve Board every day, and makes the estimates public. Comparison with the corresponding nominal yield curve allows measures of inflation compensation to be computed. We discuss the interpretation of inflation compensation, and provide evidence that it is not a pure measure of inflation expectations being distorted by inflation risk premium and liquidity premium components. We attempt to estimate the TIPS liquidity premium and to extract underlying inflation expectations. (JEL E31, E43, H63)

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    Bibliographic Info

    Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

    Volume (Year): 2 (2010)
    Issue (Month): 1 (January)
    Pages: 70-92

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    Handle: RePEc:aea:aejmac:v:2:y:2010:i:1:p:70-92

    Note: DOI: 10.1257/mac.2.1.70
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    1. Andrew W. Lo & A. Craig MacKinlay, 1987. "Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test," NBER Working Papers 2168, National Bureau of Economic Research, Inc.
    2. James H. Stock & Mark W. Watson, 2006. "Why Has U.S. Inflation Become Harder to Forecast?," NBER Working Papers 12324, National Bureau of Economic Research, Inc.
    3. Francis A. Longstaff, 2004. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 77(3), pages 511-526, July.
    4. Long Chen & David A. Lesmond & Jason Wei, 2007. "Corporate Yield Spreads and Bond Liquidity," Journal of Finance, American Finance Association, American Finance Association, vol. 62(1), pages 119-149, 02.
    5. Andrew Ang & Geert Bekaert & Min Wei, 2006. "Do macro variables, asset markets, or surveys forecast inflation better?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2006-15, Board of Governors of the Federal Reserve System (U.S.).
    6. Richardson, Matthew & Stock, James H., 1989. "Drawing inferences from statistics based on multiyear asset returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 25(2), pages 323-348, December.
    7. James H. Stock & Mark W. Watson, 2007. "Erratum to "Why Has U.S. Inflation Become Harder to Forecast?"," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(7), pages 1849-1849, October.
    8. Brian Sack & Robert Elsasser, 2004. "Treasury inflation-indexed debt: a review of the U.S. experience," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue May, pages 47-63.
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    Cited by:
    1. Murat Duran & Eda Gulsen & Orhun Sevinc, 2013. "Cesitli Enflasyon Beklentisi Olcutleri Kullanilarak Genel Bir Enflasyon Beklentisi Gostergesi Elde Edilmesi," CBT Research Notes in Economics, Research and Monetary Policy Department, Central Bank of the Republic of Turkey 1313, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    2. Duran, Murat & Gülşen, Eda, 2013. "Estimating inflation compensation for Turkey using yield curves," Economic Modelling, Elsevier, Elsevier, vol. 32(C), pages 592-601.
    3. Kitsul, Yuriy & Wright, Jonathan H., 2013. "The economics of options-implied inflation probability density functions," Journal of Financial Economics, Elsevier, Elsevier, vol. 110(3), pages 696-711.
    4. Jonathan H. Wright, 2012. "What does Monetary Policy do to Long‐term Interest Rates at the Zero Lower Bound?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 122(564), pages F447-F466, November.
    5. Chernov, Mikhail & Mueller, Philippe, 2012. "The term structure of inflation expectations," Journal of Financial Economics, Elsevier, Elsevier, vol. 106(2), pages 367-394.
    6. Oya Celasun & Lev Ratnovski & Roxana Mihet, 2012. "Commodity Prices and Inflation Expectations in the United States," IMF Working Papers 12/89, International Monetary Fund.
    7. Mark Gertler & Peter Karadi, 2014. "Monetary Policy Surprises, Credit Costs and Economic Activity," NBER Working Papers 20224, National Bureau of Economic Research, Inc.
    8. Jens Hilscher & Alon Raviv & Ricardo Reis, 2014. "Inflating Away the Public Debt? An Empirical Assessment," Working Papers, Brandeis University, Department of Economics and International Businesss School 74, Brandeis University, Department of Economics and International Businesss School.
    9. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 25, pages 755-806, October.
    10. Cartea, Álvaro & Saúl, Jonatan & Toro, Juan, 2012. "Optimal portfolio choice in real terms: Measuring the benefits of TIPS," Journal of Empirical Finance, Elsevier, Elsevier, vol. 19(5), pages 721-740.
    11. Zeng, Zheng, 2013. "New tips from TIPS: Identifying inflation expectations and the risk premia of break-even inflation," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 53(2), pages 125-139.
    12. Jonathan H. Wright, 2011. "What does Monetary Policy do to Long-Term Interest Rates at the Zero Lower Bound?," NBER Working Papers 17154, National Bureau of Economic Research, Inc.
    13. Macchiarelli, Corrado, 2011. "Bond market co-movements, expected inflation and the equilibrium real exchange rate," Working Paper Series, European Central Bank 1405, European Central Bank.

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