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Indexed Bonds and Monetary Policy: The Real Interest Rate and the Expected Rate of Inflation

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  • Kitamura, Yukinobu

    (Keio U and Bank of Japan)

Abstract

This paper presents a method for deriving the real interest rate and the expected rate of inflation from the market information contained in indexed government bonds. It also discusses the implications and potential use for monetary policy of the information derived about the real interest rate and the expected rate of inflation. In theory, the real interest rate represents the marginal product of capital or the discount rate used in intertemporal market exchanges. Therefore, it acts to signal conditions in the real economy. The expected rate of inflation represents the average expectation of market participants about future inflation. Therefore, it affects the economic decisions of market participants. It contains information about the judgment of market players, which is useful as a leading indicator of the future price level. This paper uses data on U.K. government-indexed bonds. It shows that the derived real interest rate and the expected rate of inflation provide very useful information for monetary policy. This paper also shows that the Fisher equation and the rational expectations hypothesis are incompatible, and that the expected rate of inflation obtained from the Fisher equation is far more stable than the realized rate of inflation and the expected rate of inflation obtained from the rational expectations hypothesis.

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File URL: http://www.imes.boj.or.jp/research/papers/english/me15-1-1.pdf
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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 15 (1997)
Issue (Month): 1 (May)
Pages: 1-25

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Handle: RePEc:ime:imemes:v:15:y:1997:i:1:p:1-25

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  1. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
  2. Mishkin, Frederic S., 1981. "The real interest rate: An empirical investigation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 151-200, January.
  3. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280.
  4. Svensson, L.E.O., 1994. "Estimating and Interpreting Foreward Interest Rates: Sweden 1992-1994," Papers 579, Stockholm - International Economic Studies.
  5. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-30, June.
  6. Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers fb-_88-29, Columbia - Graduate School of Business.
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