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The Information Content of the Inflation Term Structure

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  • Francis Breedon
  • Jag Chadha

Abstract

This paper examines the information content of inflation forecasts derived using index- linked and conventional bonds. The paper finds that the derived inflation term structure (ITS) gives a somewhat better indication of the bond market's inflation expectation than can be derived using either the nominal term structure or a variant employing strong assumptions about real interest rate behaviour. The inflation forecasts of the ITS also seem at least as good at forecasting future changes in inflation as forecasts derived from macroeconometric models. These characteristics of the ITS and its timeliness tend to make its inflation forecasts a useful addition to policy analysis. Because the real term structure tends to underpredict the level of future real interest rates, index-linked bonds have proved, ex post, to be cheap funding for the UK government. But we cannot be sure whether this underprediction results from an inflation risk premium or expectational error and also cannot know whether this overprediction will persist.

Suggested Citation

  • Francis Breedon & Jag Chadha, 1997. "The Information Content of the Inflation Term Structure," Bank of England working papers 75, Bank of England.
    • Handle: RePEc:boe:boeewp:75
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    References listed on IDEAS

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    Cited by:

    1. Peter S. Spiro, 2003. "Evidence on inflation expectations from Canadian real return bonds," Macroeconomics 0312004, University Library of Munich, Germany.
    2. Sharon Kozicki & P. A. Tinsley, 2012. "Effective Use of Survey Information in Estimating the Evolution of Expected Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(1), pages 145-169, February.
    3. Viktor Kotlan, 2002. "Monetary Policy and the Term Spread in a Macro Model of a Small Open Economy," Working Papers 2002/01, Czech National Bank.
    4. Tomáš Holub & Jaromír Hurník, 2008. "Ten Years of Czech Inflation Targeting: Missed Targets and Anchored Expectations," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 44(6), pages 67-86, November.
    5. J. Huston McCulloch, 2001. "The Inflation Premium implicit in the US Real and Nominal," Computing in Economics and Finance 2001 210, Society for Computational Economics.
    6. Jagjit S. Chadha & Charles Nolan, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Manchester School, University of Manchester, vol. 70(4), pages 570-595, June.
    7. 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.
    8. Christian Mose Nielsen, 2005. "The information content of the term structure of interest rates about future inflation – an illustration of the importance of accounting for a time-varying real interest rate and inflation risk premiu," Money Macro and Finance (MMF) Research Group Conference 2005 86, Money Macro and Finance Research Group.
    9. Viktor Kotlán, 2001. "Monetary policy and the term structure of interest rates in a small open economy - a model framework approach," Macroeconomics 0110003, University Library of Munich, Germany.
    10. Christian Mose Nielsen, 2006. "The Information Content Of The Term Structure Of Interest Rates About Future Inflation—An Illustration Of The Importance Of Accounting For A Time‐Varying Real Interest Rate And Inflation Risk Premium," Manchester School, University of Manchester, vol. 74(s1), pages 93-115, September.
    11. Matías Bernier B & Felipe Alarcón G. ., 2009. "Diferencias en Medidas de Compensación Inflacionaria y Swap Spread," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 12(1), pages 105-116, April.
    12. Bhundia, Ashok J. & Chadha, Jagjit S., 1998. "The information content of 3-month Sterling futures," Economics Letters, Elsevier, vol. 61(2), pages 209-214, November.
    13. Sharon Kozicki & P. A. Tinsley, 2006. "Survey-Based Estimates of the Term Structure of Expected U.S. Inflation," Staff Working Papers 06-46, Bank of Canada.
    14. Ian Christensen & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Staff Working Papers 04-43, Bank of Canada.
    15. Marfatia Hardik A., 2018. "Estimating the New Keynesian Phillips Curve for the UK: evidence from the inflation-indexed bonds market," The B.E. Journal of Macroeconomics, De Gruyter, vol. 18(1), pages 1-18, January.
    16. Hardik A. Marfatia, 2021. "Is the future really observable? A practical approach to model monetary policy rules," Empirical Economics, Springer, vol. 61(3), pages 1189-1223, September.
    17. Flávio de Freitas Val & Claudio Henrique da Silveira Barbedo & Marcelo Verdini Maia, 2011. "Inflation expectation and implicit inflation: does market research provide accurate measures?," Brazilian Business Review, Fucape Business School, vol. 8(3), pages 83-100, July.
    18. Juan Angel Garcia & Adrian van Rixtel, 2007. "Inflation-linked bonds from a central bank perspective," Occasional Papers 0705, Banco de España.
    19. J. Huston McCulloch & Levin A. Kochen, 1998. "The Inflation Premium Implicit in the US Real and Nominal Term Structures of Interest Rates," Working Papers 98-12, Ohio State University, Department of Economics.

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