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Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate

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Author Info
Christensen, Ian
Frédéric Dion
Christopher Reid

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Abstract

According to the Fisher hypothesis, the gap between Canadian nominal and Real Return Bond yields (or break-even inflation rate) should be a good measure of inflation expectations. The authors find that this measure was higher, on average, and more variable than survey measures of inflation expectations between 1992 and 2003. They examine whether risk premiums and distortions embedded in this interest rate gap can account for these facts. Their results indicate that distortions were likely an important reason for the high level and variation of this measure over much of the 1990s. There is little evidence that the distortions examined were as important between 2000 and 2003, but the high level of the break-even inflation rate in 2004 may be evidence of their return. Given the potential distortions, and the difficulty in identifying them, the authors conclude that it is premature to consider this measure a reliable gauge of monetary policy credibility. In addition, it is not as useful as competing tools for short- and medium-term inflation forecasting.

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Paper provided by Bank of Canada in its series Working Papers with number 04-43.

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Length: 47 pages
Date of creation: 2004
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Handle: RePEc:bca:bocawp:04-43

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Related research
Keywords: Interest rates; Inflation and prices; Market structure and pricing;

Other versions of this item:

Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Ben Craig, 2003. "Why are TIIS yields so high? The case of the missing inflation-risk premium," Economic Commentary, Federal Reserve Bank of Cleveland, issue Mar 15. [Downloadable!]
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    Other versions:
  4. Martin D. D. Evans, 1998. "Real Rates, Expected Inflation, and Inflation Risk Premia," Journal of Finance, American Finance Association, vol. 53(1), pages 187-218, 02. [Downloadable!] (restricted)
  5. 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.
    Other versions:
  6. Pu Shen & Jonathan Corning, 2001. "Can TIPS help identify long-term inflation expectations?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 61-87. [Downloadable!]
  7. Christopher Reid & Frédéric Dion & Ian Christensen, 2004. "Real Return Bonds: Monetary Policy Credibility and Short-Term Inflation Forecasting," Bank of Canada Review, Bank of Canada, vol. 2004(Autumn), pages 15-26. [Downloadable!]
  8. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Data," Harvard Institute of Economic Research Working Papers 1758, Harvard - Institute of Economic Research.
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  11. Crawford, A & Kasumovich, M, 1996. "Does Inflation Uncertainty Vary with the Level of Inflation?," Working Papers 96-09, Bank of Canada. [Downloadable!]
  12. Frédérick Demers, 2003. "The Canadian Phillips Curve and Regime Shifting," Working Papers 03-32, Bank of Canada. [Downloadable!]
  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. [Downloadable!]
  14. Brian Sack, 2000. "Deriving inflation expectations from nominal and inflation-indexed Treasury yields," Finance and Economics Discussion Series 2000-33, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  15. William R. Emmons, 2000. "The information content of Treasury inflation-indexed securities," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 25-38. [Downloadable!]
  16. David Jamieson Bolder & Scott Gusba, 2002. "Exponentials, Polynomials, and Fourier Series: More Yield Curve Modelling at the Bank of Canada," Working Papers 02-29, Bank of Canada. [Downloadable!]
  17. Thomas Mayer, 1993. "Indexed Bonds and Heterogeneous Agents," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich.
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  18. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2003. "The excess sensitivity of long-term interest rates: evidence and implications for macroeconomic models," Finance and Economics Discussion Series 2003-50, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  19. Agathe Côté & Jocelyn Jacob & John Nelmes & Miles Whittingham, 1996. "Inflation expectations and Real Return Bonds," Bank of Canada Review, Bank of Canada, vol. 1996(Summer), pages 41-53. [Downloadable!]
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Marielle de Jong & Gilbert Cette, 2008. "The rocky ride of break-even inflation rates," Economics Bulletin, Economics Bulletin, vol. 5(31), pages 1-8. [Downloadable!]
    Other versions:
  2. David J. Bolder & Grahame Johnson & Adam Metzler, 2004. "An Empirical Analysis of the Canadian Term Structure of Zero-Coupon Interest Rates," Working Papers 04-48, Bank of Canada. [Downloadable!]
  3. 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. [Downloadable!]
  4. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a central bank perspective," Banco de España Occasional Papers 0705, Banco de España. [Downloadable!]
    Other versions:
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