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The Term Structure of Interest Rates and Inflation Forecast Targeting

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  • Eijffinger, Sylvester C W
  • Schaling, Eric
  • Verhagen, Willem

Abstract

This paper examines the implications of the expectations theory of the term structure for the implementation of inflation targeting. We show that the responsiveness of the central bank's instrument to the underlying state of the economy is increasing in the duration of the long-term bond. On the other hand, an increase in duration will make long-term inflationary expectations and therefore also the long-term nominal interest rate less responsive to the state of the economy. The extent to which the central bank cares about output stabilization will exert a moderating influence on the central bank's response to the current indicators of future inflation. However, the effect of an increase in this parameter on the long-term nominal interest rate turns out to be ambiguous. Next, we show that both the sensitivity of the nominal term spread to economic fundamentals and the extent to which the spread predicts future output are increasing in the duration of the long bond and the degree of structural output persistence. However, if the central bank becomes relatively less concerned about inflation stabilization the term spread will be less successful in predicting real economic activity.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2375.

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Date of creation: Feb 2000
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Handle: RePEc:cpr:ceprdp:2375

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Keywords: Inflation Targets; Term Structure of Interest Rates;

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Cited by:
  1. Gerlach-Kristen, Petra & Rudolf, Barbara, 2010. "Financial shocks and the maturity of the monetary policy rate," Economics Letters, Elsevier, vol. 107(3), pages 333-337, June.
  2. Mewael F. Tesfaselassie & Eric Schaling & Sylvester Eijffinger, 2007. "Learning About the Term Structure and Optimal Rules for Inflation Targeting," Working Papers 62, Economic Research Southern Africa.
  3. Bruno Ducoudre & Antoine Bouveret, 2007. "On the Contingency of Equilibrium Exchange Rates with Time - Consistent Economic Policies," Sciences Po publications 2007-08, Sciences Po.
  4. Kevin J. Lansing & Bharat Trehan, 2003. "Forward-looking behavior and optimal discretionary monetary policy," Working Paper Series 2001-03, Federal Reserve Bank of San Francisco.
  5. Driffill, John & Rotondi, Zeno, 2007. "Inertia in Taylor Rules," CEPR Discussion Papers 6570, C.E.P.R. Discussion Papers.
  6. 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., vol. 44(6), pages 67-86, November.
  7. Schaling, E. & Eijffinger, S.C.W. & Tesfaselassie, M.F., 2004. "Heterogeneous Information about the Term Structure of Interest rates, Least-Squares Learning and Optimal Interest Rate Rules for Inflation Forecast Targeting," Discussion Paper 2004-14, Tilburg University, Center for Economic Research.
  8. Petra Gerlach-Kristen & Barbara Rudolf, 2010. "Macroeconomic and interest rate volatility under alternative monetary operating procedures," BIS Working Papers 319, Bank for International Settlements.
  9. Eijffinger, Sylvester C W & Schaling, Eric & Tesfaselassie, Mewael F., 2004. "Heterogenous Information About the Term Structure of Interest Rates, Least-Squares Learning and Optimal Interest Rate Rules," CEPR Discussion Papers 4279, C.E.P.R. Discussion Papers.
  10. Viktor Kotlán, 2001. "Monetary policy and the term structure of interest rates in a small open economy - a model framework approach," Macroeconomics 0110003, EconWPA.
  11. Schaling , Eric & Eijffinger , Sylvester & Tesfaselassie , Mewael, 2004. "Heterogeneous information about the term structure, least-squares learning and optimal rules for inflation targeting," Research Discussion Papers 23/2004, Bank of Finland.
  12. Söderström, Ulf, 1999. "Should central banks be more aggressive?," Working Paper Series 84, Sveriges Riksbank (Central Bank of Sweden).

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