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The Information Content of the Inflation Term Structure

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  • Francis Breedon
  • Jag Chadha

Abstract

This paper examines the information content of inflation forecasts derived using index- linked and conventional bonds. The paper finds that the derived inflation term structure (ITS) gives a somewhat better indication of the bond market's inflation expectation than can be derived using either the nominal term structure or a variant employing strong assumptions about real interest rate behaviour. The inflation forecasts of the ITS also seem at least as good at forecasting future changes in inflation as forecasts derived from macroeconometric models. These characteristics of the ITS and its timeliness tend to make its inflation forecasts a useful addition to policy analysis. Because the real term structure tends to underpredict the level of future real interest rates, index-linked bonds have proved, ex post, to be cheap funding for the UK government. But we cannot be sure whether this underprediction results from an inflation risk premium or expectational error and also cannot know whether this overprediction will persist.

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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 75.

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Date of creation: Dec 1997
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Handle: RePEc:boe:boeewp:75

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  1. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Debt," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1125, Cowles Foundation for Research in Economics, Yale University.
  2. Bennett T. McCallum, 2005. "Monetary policy and the term structure of interest rates," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Fall, pages 1-21.
  3. Eric J Levin & Laurence S Copeland, 1992. "Reading the Message from the UK Indexed Bond Market: Real Interest Rates, Expected Inflation and the Risk Premium," Working Papers Series, University of Stirling, Division of Economics 92/8, University of Stirling, Division of Economics.
  4. Donald Robertson & James Symons, 1993. "Real Interest Rates and Index Linked Gilts," CEP Discussion Papers dp0181, Centre for Economic Performance, LSE.
  5. N. Gregory Mankiw, 1986. "The Term Structure of Interest Rates Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(1), pages 61-110.
  6. Frankel, Jeffrey A & Lown, Cara S, 1994. "An Indicator of Future Inflation Extracted from the Steepness of the Interest Rate Yield Curve along Its Entire Length," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(2), pages 517-30, May.
  7. Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers, Columbia - Graduate School of Business fb-_88-29, Columbia - Graduate School of Business.
  8. D. Robertson & J. Symons, 1993. "Real interest rates and index linked gilts," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 20923, London School of Economics and Political Science, LSE Library.
  9. Frederic S. Mishkin, 1991. "Is the Fisher Effect for Real? A Reexamination of the Relationship Between Inflation and Interest Rates," NBER Working Papers 3632, National Bureau of Economic Research, Inc.
  10. Mishkin, Frederic S, 1990. "The Information in the Longer Maturity Term Structure about Future Inflation," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(3), pages 815-28, August.
  11. John Y. Campbell & Robert J. Shiller, 1989. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," NBER Working Papers 3153, National Bureau of Economic Research, Inc.
  12. Jeffrey A. Frankel, 1979. "A technique for extracting a measure of expected inflation from the interest rate term structure," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 148, Board of Governors of the Federal Reserve System (U.S.).
  13. Shmuel Kandel & Aharon R. Ofer & Oded Sarig, . "Real Interest Rates and Inflation: An Ex-Ante Empirical Analysis," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 2-95, Wharton School Rodney L. White Center for Financial Research.
  14. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(3), pages 509-34, June.
  15. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 60(4), pages 473-89, October.
  16. Söderlind, Paul, 1995. "Forward Interest Rates as Indicators of Inflation Expectations," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1313, C.E.P.R. Discussion Papers.
  17. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
  18. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Data," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1758, Harvard - Institute of Economic Research.
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Cited by:
  1. Matías Bernier B & Felipe Alarcón G. ., 2009. "Diferencias en Medidas de Compensación Inflacionaria y Swap Spread," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, Central Bank of Chile, vol. 12(1), pages 105-116, April.
  2. Christensen, Ian & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Working Papers, Bank of Canada 04-43, Bank of Canada.
  3. Sharon Kozicki & P.A. Tinsley, 2006. "Survey-Based Estimates of the Term Structure of Expected U.S. Inflation," Working Papers, Bank of Canada 06-46, Bank of Canada.
  4. Chadha, Jagjit S & Nolan, Charles, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Manchester School, University of Manchester, vol. 70(4), pages 570-95, Special I.
  5. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a Central Bank perspective," Occasional Paper Series 62, European Central Bank.
  6. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics, EconWPA 0312004, EconWPA.
  7. Tomáš Holub & Jaromír Hurník, 2008. "Ten Years of Czech Inflation Targeting: Missed Targets and Anchored Expectations," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., M.E. Sharpe, Inc., vol. 44(6), pages 67-86, November.
  8. Bhundia, Ashok J. & Chadha, Jagjit S., 1998. "The information content of 3-month Sterling futures," Economics Letters, Elsevier, Elsevier, vol. 61(2), pages 209-214, November.
  9. Flávio de Freitas Val & Claudio Henrique da Silveira Barbedo & Marcelo Verdini Maia, 2011. "Inflation expectation and implicit inflation: does market research provide accurate measures?," Brazilian Business Review, Fucape Business School, Fucape Business School, vol. 8(3), pages 83-100, July.
  10. J. Huston McCulloch & Levin A. Kochen, 1998. "The Inflation Premium Implicit in the US Real and Nominal Term Structures of Interest Rates," Working Papers, Ohio State University, Department of Economics 98-12, Ohio State University, Department of Economics.
  11. Viktor Kotlán, 2001. "Monetary policy and the term structure of interest rates in a small open economy - a model framework approach," Macroeconomics, EconWPA 0110003, EconWPA.
  12. Christian Mose Nielsen, 2005. "The information content of the term structure of interest rates about future inflation – an illustration of the importance of accounting for a time-varying real interest rate and inflation risk prem," Money Macro and Finance (MMF) Research Group Conference 2005, Money Macro and Finance Research Group 86, Money Macro and Finance Research Group.
  13. J. Huston McCulloch, 2001. "The Inflation Premium implicit in the US Real and Nominal," Computing in Economics and Finance 2001, Society for Computational Economics 210, Society for Computational Economics.

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