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Can TIPS help identify long-term inflation expectations?

  • Pu Shen
  • Jonathan Corning
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    Investors and policymakers have long hoped that Treasury Inflation Protected Securities (TIPS) would provide an accurate measure of long-term market inflation expectations. To make informed decisions and to ensure that inflation does not erode the purchasing power of their assets, investors need to assess the rate of inflation expected by other market participants. Having an accurate measure of market inflation expectations can also help policymakers assess their effectiveness in controlling long-term inflation, as well as their credibility among market participants.> Until recently, however, the only sources of information about long-term inflation expectations were surveys and the term structure of interest rates, neither of which were considered highly reliable. With the introduction of TIPS in 1997, it was hoped that a new measure of market inflation expectations—the difference in yields between conventional Treasuries and TIPS—would become available.> Shen and Corning examine the empirical evidence on the behavior of the yield difference and the liquidity of the TIPS market. They find that the yield difference has not provided a good measure of market inflation expectations because of the large and variable liquidity premium on TIPS. Still, the yield difference may become a better measure of market inflation expectations as liquidity conditions in the two kinds of Treasury markets move closer in the future.

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    Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

    Volume (Year): (2001)
    Issue (Month): Q IV ()
    Pages: 61-87

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    Handle: RePEc:fip:fedker:y:2001:i:qiv:p:61-87:n:v.86no.4
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    1. David G. Barr & John Y. Campbell, 1996. "Inflation, Real Interest Rates, and the Bond Market: A Study of UK Nominal and Index-Linked Government Bond Prices," NBER Working Papers 5821, National Bureau of Economic Research, Inc.
    2. Dominique Dupont & Brian Sack, 1999. "The Treasury securities market: overview and recent development," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 785-806.
    3. Pu Shen, 1998. "How important is the inflation risk premium?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 35-47.
    4. Mark Deacon & Andrew Derry, 1994. "Deriving Estimates of Inflation Expectations from the Prices of UK Government Bonds," Bank of England working papers 23, Bank of England.
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