Do interest rates help predict inflation?

Accurate forecasts of inflation are important to policymakers and to individuals who must make decisions on the basis of expectations about the future purchasing power of the dollar. ; Recent research on forecasting inflation has shown that interest rates, by themselves, may provide useful information about future inflation. In this article, Kenneth M. Emery and Evan F. Koenig investigate whether interest rates contain information about future inflation beyond that found in traditional inflation-forecasting models. In other words, does adding interest rates to traditional inflation models enhance the models' forecasting ability? Emery and Koenig find that including interest rates does significantly improve the forecasting ability of traditional models. They also find, in contrast to recent research focusing on the forecasting ability of interest rates in isolation, that the information content of interest rates did not diminish in the 1980s. ; Emery and Koenig point out that whether the historical forecasting ability of interest rates can be exploited by policymakers is problematic. Because interest rates reflect expectations of future monetary policy, if the Federal Reserve were to begin relying more on interest rates as a guide to policy, the relationship between interest rates and inflation would likely change.