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Evidence on inflation expectations from Canadian real return bonds

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  • Peter S. Spiro

    (Ontario Ministry of Finance)

Abstract

Starting with the UK in 1981, many of the industrialized countries have issued long-term bonds whose principal value is indexed to the rate of inflation. One of the benefits that economists predicted from issuing such bonds is that the difference between the yield on indexed and nominal bonds would be an indicator of the market’s expectations of inflation. This could be a useful guide for central banks in judging the success of their monetary policy in stabilizing the inflation rate. This paper examines the data from Canada, which began issuing indexed (“real return”) bonds in 1991. It is found that it is possible to explain the relationship between real and nominal bonds with very small residuals, using a moving average of historical inflation and the US bond yield as explanatory variables. The implication is that expectations in the nominal bond market are adaptive rather than forward looking. Therefore, while we are able to infer the market’s expectations of inflation with a high degree of precision, this is not actually very useful as a guide to monetary policy or predicting future inflation.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0312004.

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Length: 20 pages
Date of creation: 05 Dec 2003
Date of revision:
Handle: RePEc:wpa:wuwpma:0312004

Note: Type of Document - pdf; prepared on Win2000; pages: 20; figures: 5
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Web page: http://128.118.178.162

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Keywords: indexed bonds inflation rational expectations;

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References

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  1. 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.).
  2. 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.
  3. Peter S. Spiro, 1990. "The Effect of Government Debt on Short-Term Real Interest Rates: Comment on Findlay," IMF Staff Papers, Palgrave Macmillan, vol. 37(4), pages 881-888, December.
  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.
  5. Francis Breedon & Jagjit S. Chadha, 2003. "Investigating Excess Returns from Nominal Bonds," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(1), pages 73-90, February.
  6. Chan G. Huh & Kevin J. Lansing, 1998. "Expectations, credibility, and disinflation in a small macroeconomic model," Working Papers in Applied Economic Theory 98-01, Federal Reserve Bank of San Francisco.
  7. Martin D. D. Evans, 2003. "Real risk, inflation risk, and the term structure," Economic Journal, Royal Economic Society, vol. 113(487), pages 345-389, 04.
  8. Robert J. Shiller, 2003. "From Efficient Markets Theory to Behavioral Finance," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 83-104, Winter.
  9. Francis Breedon & Jag Chadha, 1997. "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England.
  10. Glaser, Markus & Nöth, Markus & Weber, Martin, 2003. "Behavioral Finance," Sonderforschungsbereich 504 Publications 03-14, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
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Cited by:
  1. Andreas Reschreiter, 2010. "Indexed bonds and revisions of inflation expectations," Annals of Finance, Springer, vol. 6(4), pages 537-554, October.

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