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Can TIPS help identify long-term inflation expectations?

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  • Pu Shen
  • Jonathan Corning
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    Abstract

    Investors and policymakers have long hoped that Treasury Inflation Protected Securities (TIPS) would provide an accurate measure of long-term market inflation expectations. To make informed decisions and to ensure that inflation does not erode the purchasing power of their assets, investors need to assess the rate of inflation expected by other market participants. Having an accurate measure of market inflation expectations can also help policymakers assess their effectiveness in controlling long-term inflation, as well as their credibility among market participants.> Until recently, however, the only sources of information about long-term inflation expectations were surveys and the term structure of interest rates, neither of which were considered highly reliable. With the introduction of TIPS in 1997, it was hoped that a new measure of market inflation expectations—the difference in yields between conventional Treasuries and TIPS—would become available.> Shen and Corning examine the empirical evidence on the behavior of the yield difference and the liquidity of the TIPS market. They find that the yield difference has not provided a good measure of market inflation expectations because of the large and variable liquidity premium on TIPS. Still, the yield difference may become a better measure of market inflation expectations as liquidity conditions in the two kinds of Treasury markets move closer in the future.

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    File URL: http://www.kansascityfed.org/Publicat/econrev/Pdf/4q01shen.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

    Volume (Year): (2001)
    Issue (Month): Q IV ()
    Pages: 61-87

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    Handle: RePEc:fip:fedker:y:2001:i:qiv:p:61-87:n:v.86no.4

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    Related research

    Keywords: Inflation (Finance) ; Government securities;

    References

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    1. Dominique Dupont & Brian Sack, 1999. "The Treasury securities market: overview and recent development," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 785-806.
    2. David Barr & John Campbell, . "Inflation, real interest rates and the bond market: a study of UK nominal and index-linked Government bond prices," CERF Discussion Paper Series 95-09, Economics and Finance Section, School of Social Sciences, Brunel University.
    3. Pu Shen, 1998. "How important is the inflation risk premium?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 35-47.
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    Citations

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    Cited by:
    1. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics 0312004, EconWPA.
    2. Wilbert van der Klaauw & Wändi Bruine de Bruin & Giorgio Topa & Simon Potter & Michael Bryan, 2008. "Rethinking the measurement of household inflation expectations: preliminary findings," Staff Reports 359, Federal Reserve Bank of New York.
    3. Andolfatto, David & Hendry, Scott & Moran, Kevin, 2008. "Are inflation expectations rational?," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 406-422, March.
    4. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a central bank perspective," Banco de Espa�a Occasional Papers 0705, Banco de Espa�a.
    5. Koijen, Ralph S.J. & Hemert, Otto Van & Nieuwerburgh, Stijn Van, 2009. "Mortgage timing," Journal of Financial Economics, Elsevier, vol. 93(2), pages 292-324, August.
    6. Christensen, Ian & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Working Papers 04-43, Bank of Canada.
    7. Laatsch, Francis E. & Klein, Daniel P., 2005. "The nominal duration of TIPS bonds," Review of Financial Economics, Elsevier, vol. 14(1), pages 47-60.
    8. Andolfatto, David & Scott Hendry & Kevin Moran, 2002. "Inflation Expectations and Learning about Monetary Policy," Working Papers 02-30, Bank of Canada.
    9. Kosuke Aoki & Takeshi Kimura, 2008. "Central bank's two-way communication with the public and inflation dynamics," LSE Research Online Documents on Economics 25483, London School of Economics and Political Science, LSE Library.
    10. Quentin Chu & Deborah Pittman & Linda Yu, 2005. "Information Risk in TIPS Market: An Analysis of Nominal and Real Interest Rates," Review of Quantitative Finance and Accounting, Springer, vol. 24(3), pages 235-250, May.
    11. Sharon Kozicki & P.A. Tinsley, 2006. "Survey-Based Estimates of the Term Structure of Expected U.S. Inflation," Working Papers 06-46, Bank of Canada.
    12. Moerman, Gerard A. & van Dijk, Mathijs A., 2010. "Inflation risk and international asset returns," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 840-855, April.
    13. 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, issue May, pages 47-63.

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