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Forward Interest Rates as Indicators of Inflation Expectations

Forward interest rates have become popular indicators of inflation expectations. The usefulness of this indicator depends on the relative volatilty and the correlation of inflation expectations and expected real interest rates. This paper studies U.S. and U.K. data, using a range of different tools and data sets. The forward rate rule perfoms reasonably well, in spite of significant movements in the expected real interest rate. The reason is that the 'noise' that movements in the expected real interest rate add to the inflation expectations is balanced by a tendency for expected real interest rates and inflation expectations to move in opposite directions.

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File URL: http://su.diva-portal.org/smash/get/diva2:327078/FULLTEXT01
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Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 594.

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Length: 28 pages
Date of creation: 31 Oct 1997
Date of revision:
Handle: RePEc:hhs:iiessp:0594
Contact details of provider: Postal: Institute for International Economic Studies, Stockholm University, S-106 91 Stockholm, Sweden
Phone: +46-8-162000
Fax: +46-8-161443
Web page: http://www.iies.su.se/
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  1. Jeffrey A. Frankel & Cara S. Lown, 1991. "An Indicator of Future Inflation Extracted From the Steepness of the Interest Rate Yield Curve Along Its Entire Length," NBER Working Papers 3751, National Bureau of Economic Research, Inc.
  2. Deaton, Angus, 1992. "Understanding Consumption," OUP Catalogue, Oxford University Press, number 9780198288244, March.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
  4. Christopher Ragan, 1995. "Deriving Agents' Inflation Forecasts from the Term Structure of Interest Rates," Macroeconomics 9502003, EconWPA.
  5. Milton Friedman & Anna Jacobson Schwartz, 1970. "Monetary Statistics of the United States: Estimates, Sources, Methods," NBER Books, National Bureau of Economic Research, Inc, number frie70-1, November.
  6. Pearce, Douglas K, 1987. "Short-term Inflation Expectations: Evidence from a Monthly Survey: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 388-95, August.
  7. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280.
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