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Evidence on inflation expectations from Canadian real return bonds

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Author Info
Peter S. Spiro (Ontario Ministry of Finance)

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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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Publisher 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
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Handle: RePEc:wpa:wuwpma:0312004

Note: Type of Document - pdf; prepared on Win2000; pages: 20; figures: 5
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Web page: http://129.3.20.41

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Related research
Keywords: indexed bonds inflation rational expectations

Find related papers by JEL classification:
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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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. 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. [Downloadable!] (restricted)
  2. 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)
  3. 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!]
  4. 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. [Downloadable!] (restricted)
  5. Francis Breedon & Jag Chadha, . "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England. [Downloadable!]
  6. Huh, Chan G. & Lansing, Kevin J., 2000. "Expectations, credibility, and disinflation in a small macroeconomic model," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 51-86. [Downloadable!] (restricted)
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  7. repec:fip:fedreq:y:1992:i:jan/feb:p:13-23:n:v.78no.1 is not listed on IDEAS
  8. 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!]
  9. 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. [Downloadable!] (restricted)
    Other versions:
  10. 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!]
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