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Extracting Deflation Probability Forecasts from Treasury Yields

  • Jens H.E. Christensen

    (Federal Reserve Bank of San Francisco)

  • Jose A. Lopez

    (Federal Reserve Bank of San Francisco)

  • Glenn D. Rudebusch

    (Federal Reserve Bank of San Francisco)

We construct probability forecasts for episodes of price deflation (i.e., a falling price level) using yields on nominal and real U.S. Treasury bonds. The deflation probability forecasts identify two “deflation scares” during the past decade: a mild one following the 2001 recession and a more serious one starting in late 2008 with the deepening of the financial crisis. The estimated deflation probabilities are generally consistent with those from macroeconomic models and surveys of professional forecasters, but they also provide high-frequency insight into the views of financial market participants. The probabilities can also be used to price the deflation protection option embedded in real Treasury bonds.

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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 8 (2012)
Issue (Month): 4 (December)
Pages: 21-60

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Handle: RePEc:ijc:ijcjou:y:2012:q:4:a:2
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  2. Christensen, Jens H.E. & Diebold, Francis X. & Rudebusch, Glenn D., 2011. "The affine arbitrage-free class of Nelson-Siegel term structure models," Journal of Econometrics, Elsevier, vol. 164(1), pages 4-20, September.
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  15. Taimur Baig & Jörg Decressin & Tarhan Feyzioglu & Manmohan S. Kumar & Chris Faulkner-MacDonagh, 2003. "Deflation: Determinants, Risks, and Policy Options," IMF Occasional Papers 221, International Monetary Fund.
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