Monetary Policy, Expected Inflation, and Inflation Risk Premium
negatively correlated, (iii) short-term real interest rates display greater volatility than expected inflation, (iv) nominal interest rates and expected inflation are negatively correlated for short maturities, but positively correlated for long maturities, (v) inflation risk premia are very small and very constant, and (vi) inflation risk premia and expected inflation are significantly negatively correlated. Results (ii) and (iii) are consistent with empirical evidence in Pennacchi (1991). Finally, we show that our economy is consistent with Mundell-Tobin Effect, that is, increases in inflation are associated with higher nominal interest rates, but lower real interest rates.
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