IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/0231.html

Who Puts the Inflation Premium Into Nominal Interests Rates?

Author

Listed:
  • Benjamin M. Friedman

Abstract

For expectations of price inflation to affect interest rates, they must affect the behavior of borrowers and lenders or both. This paper analyzes the emergence of the inflation premium in long-term interest rates as the explicit result of borrowers' and lenders' behavior in the bond market in response to price expectations. The object of this analysis is not only to estimate the magnitude of the inflation premium due to this portfolio behavior but also to evaluate the respective contributions to it of borrowers' and lenders' responses. The empirical results presented in this paper indicate that both borrowers' and lenders' portfolio behavior play an important role in the relationship between interest rates and inflation expectations. Estimation results for U.S. data provide evidence that, all other things equal, nonfinancial business corporations increase their supply (net issuance)of bonds in response to an increase in expected inflation; these results mirror the bond investors' responses found by the author in a previous paper. Partial equilibrium experiments based on the combined model of bond supply and bond demand indicate that, all other things equal, the port-folio responses to expected price inflation by borrowers and lenders together increase the bond yield by 2/3%, and modestly decrease the net quantity of bonds issued and purchased, in response to a 1% increase in expected inflation. This result follows as the consequence of a slightly greater response by lenders than by borrowers.

Suggested Citation

  • Benjamin M. Friedman, 1978. "Who Puts the Inflation Premium Into Nominal Interests Rates?," NBER Working Papers 0231, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0231
    Note: ME
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w0231.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Benjamin M. Friedman & V. Vance Roley, 1977. "Identifying Identical Distributed Lag Structures by the Use of Prior SumConstraints," NBER Working Papers 0179, National Bureau of Economic Research, Inc.
    2. Thomas J. Sargent, 1973. "Rational Expectations, the Real Rate of Interest, and the Natural Rate of Unemployment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 4(2), pages 429-480.
    3. McCallum, Bennett T, 1976. "Rational Expectations and the Natural Rate Hypothesis: Some Consistent Estimates," Econometrica, Econometric Society, vol. 44(1), pages 43-52, January.
    4. Paul A. Samuelson, 1958. "An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money," Journal of Political Economy, University of Chicago Press, vol. 66(6), pages 467-467.
    5. Sargent, Thomas J, 1971. "A Note on the 'Accelerationist' Controversy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(3), pages 721-725, August.
    6. Friedman, Benjamin Morton, 1977. "Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates," Scholarly Articles 4554309, Harvard University Department of Economics.
    7. Benjamin M. Friedman & V. Vance Roles, 1977. "Identifying Identical Distributed Lag Structures by the Use of Prior Sum Constraints," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 6, number 4, pages 429-444, National Bureau of Economic Research, Inc.
    8. Fama, Eugene F, 1970. "Multiperiod Consumption-Investment Decisions," American Economic Review, American Economic Association, vol. 60(1), pages 163-174, March.
    9. Smith, Gary, 1975. "Pitfalls in Financial Model Building: A Clarification," American Economic Review, American Economic Association, vol. 65(3), pages 510-516, June.
    10. repec:bla:econom:v:40:y:1973:i:157:p:12-43 is not listed on IDEAS
    11. Ladenson, Mark L, 1971. "Pitfalls in Financial Model Building: Some Extensions," American Economic Review, American Economic Association, vol. 61(1), pages 179-186, March.
    12. Bodie, Zvi & Friedman, Benjamin M, 1978. "Interest Rate Uncertainty and the Value of Bond Call Protection," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 19-43, February.
    13. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43, National Bureau of Economic Research, Inc.
    14. Brundy, James M & Jorgenson, Dale W, 1971. "Efficient Estimation of Simultaneous Equations by Instrumental Variables," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 207-224, August.
    15. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation for Research in Economics, Yale University.
    16. Friedman, Benjamin M, 1977. "Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates," Journal of Political Economy, University of Chicago Press, vol. 85(4), pages 661-689, August.
    17. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-276, June.
    18. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters, in: Leonard C MacLean & Edward O Thorp & William T Ziemba (ed.), THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472, World Scientific Publishing Co. Pte. Ltd..
    19. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-257, August.
    20. Rutledge, John, 1977. "Irving Fisher and Autoregressive Expectations," American Economic Review, American Economic Association, vol. 67(1), pages 200-205, February.
    21. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71(3), pages 280-280.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Nelson, Edward & Schwartz, Anna J., 2008. "The impact of Milton Friedman on modern monetary economics: Setting the record straight on Paul Krugman's "Who was Milton Friedman?"," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 835-856, May.
    2. Wilbur G. Lewellen & James S. Ang, 1982. "Inflation, Security Values, And Risk Premia," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 5(2), pages 105-123, June.
    3. Benjamin M. Friedman, 1982. "Interest Rate Implications for Fiscal and Monetary Policies: A Postscript on the Government Budget Constraint," NBER Working Papers 0886, National Bureau of Economic Research, Inc.
    4. Benjamin M. Friedman, 1982. "Federal Reserve Policy, Interest Rate Volatility, and the U.S. Capital Raising Mechanism," NBER Working Papers 0917, National Bureau of Economic Research, Inc.
    5. Aryo Sasongko & Cicilia Anggadewi Harun & Geyana Ledy Fista & Kusfisiami Wima Mustika & Aninditha Kemala Dinianyadharani & Karanissa Larasati & Puput Kurniati & Dila Safitri, 2024. "Modeling And Analysis Of Yield Curve And Exchange Rate Formation In Pro-Market Monetary Operations," Working Papers WP/09/2024, Bank Indonesia.
    6. Benjamin M. Friedman, 1979. "The Determination of Long-Term Interest Rates: Implications for Monetary and Fiscal Policies," NBER Working Papers 0366, National Bureau of Economic Research, Inc.
    7. Adeel Riaz & Assad Ullah & Bashir Muhammad, 2025. "The impact of global supply chain pressure on the stock market: A sectoral view," Humanities and Social Sciences Communications, Palgrave Macmillan, vol. 12(1), pages 1-10, December.
    8. Benjamin M. Friedman & V. Vance Roley, 1981. "Structural Models of Interest Rate Determination and Portfolio Behavior in the Corporate and Government Bond Markets," NBER Working Papers 0205, National Bureau of Economic Research, Inc.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Benjamin M. Friedman, 1978. "Price Inflation, Portfolio Choice, and Nominal Interest Rates," NBER Working Papers 0235, National Bureau of Economic Research, Inc.
    2. Alho, Kari, . "Analysis of Financial Markets and Central Bank Policy in the Flow-of-Funds Framework. An Application to the Case of Finland," ETLA A, The Research Institute of the Finnish Economy, number 12, June.
    3. Benjamin M. Friedman & V. Vance Roley, 1981. "Structural Models of Interest Rate Determination and Portfolio Behavior in the Corporate and Government Bond Markets," NBER Working Papers 0205, National Bureau of Economic Research, Inc.
    4. Benjamin M. Friedman & V. Vance Roley, 1985. "Aspects of Investor Behavior Under Risk," NBER Working Papers 1611, National Bureau of Economic Research, Inc.
    5. Benjamin M. Friedman, 1980. "The Effect of Shifting Wealth Ownership on the Term Structure of Interest Rates," NBER Working Papers 0239, National Bureau of Economic Research, Inc.
    6. V. Vance Roley, 1980. "Symmetry Restrictions in a System of Financial Asset Demands: A Theoretical and Empirical Analysis," NBER Working Papers 0593, National Bureau of Economic Research, Inc.
    7. V. Vance Roley, 1983. "Asset Substitutability and the Impact of Federal Deficits," NBER Working Papers 1082, National Bureau of Economic Research, Inc.
    8. Friedman, Benjamin Morton, 1977. "Financial Flow Variables and the Short-Run Determination of Long-Term Interest Rates," Scholarly Articles 4554309, Harvard University Department of Economics.
    9. V. Vance Roley, 1980. "The Effect of Federal Debt Management Policy on Corporate Bond and Equity Yields," NBER Working Papers 0586, National Bureau of Economic Research, Inc.
    10. Thierry Chauveau & Patrick Frochen, 1983. "Etude du comportement de l'épargnant français vis-à-vis des liquidités : 1971-1981," Revue Économique, Programme National Persée, vol. 34(1), pages 152-181.
    11. Martin Feldstein, 1983. "Fiscal Policies, Inflation, and Capital Formation," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 61-80, National Bureau of Economic Research, Inc.
    12. R. Glenn Hubbard, 1984. "Social Security and Household Portfolio Allocation," NBER Working Papers 1361, National Bureau of Economic Research, Inc.
    13. Dokuchaev, Nikolai, 2010. "Optimality of myopic strategies for multi-stock discrete time market with management costs," European Journal of Operational Research, Elsevier, vol. 200(2), pages 551-556, January.
    14. Zhang, Xili & Zhang, Weiguo & Xiao, Weilin, 2013. "Multi-period portfolio optimization under possibility measures," Economic Modelling, Elsevier, vol. 35(C), pages 401-408.
    15. Mihir A. Desai & James R. Hines, Jr., 1999. "Excess Capital Flows and the Burden of Inflation in Open Economies," NBER Chapters, in: The Costs and Benefits of Price Stability, pages 235-272, National Bureau of Economic Research, Inc.
    16. Chen, Jia & Li, Degui & Linton, Oliver & Lu, Zudi, 2016. "Semiparametric dynamic portfolio choice with multiple conditioning variables," Journal of Econometrics, Elsevier, vol. 194(2), pages 309-318.
    17. Anari, Ali & Kolari, James, 2016. "Dynamics of interest and inflation rates," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 129-144.
    18. İsmet Göçer & Serdar Ongan, 2020. "Asymmetric Impacts of Inflation on the US Bond Rates and FED’s Pre-Emptive Policy," Econometric Research in Finance, SGH Warsaw School of Economics, Collegium of Economic Analysis, vol. 5(2), pages 143-157, December.
    19. Scholten, Ulrich, 1999. "Die Förderung von Wohneigentum," Beiträge zur Finanzwissenschaft, Mohr Siebeck, Tübingen, edition 1, volume 8, number urn:isbn:9783161472343, September.
    20. Christopher J. Neely & David E. Rapach, 2008. "Real interest rate persistence: evidence and implications," Review, Federal Reserve Bank of St. Louis, vol. 90(Nov), pages 609-642.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:0231. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.