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Monetary Policy, Expected Inflation, and Inflation Risk Premium

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  • Juha Seppala

    (University of Illinois)

  • Federico Ravenna

    (University of California)

Abstract

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.

Suggested Citation

  • Juha Seppala & Federico Ravenna, 2007. "Monetary Policy, Expected Inflation, and Inflation Risk Premium," 2007 Meeting Papers 513, Society for Economic Dynamics.
  • Handle: RePEc:red:sed007:513
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    File URL: https://economicdynamics.org/meetpapers/2007/paper_513.pdf
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    References listed on IDEAS

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    1. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    2. Andrew Ang & Geert Bekaert & Min Wei, 2008. "The Term Structure of Real Rates and Expected Inflation," Journal of Finance, American Finance Association, vol. 63(2), pages 797-849, April.
    3. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, January.
    4. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
    5. Pennacchi, George G, 1991. "Identifying the Dynamics of Real Interest Rates and Inflation: Evidence Using Survey Data," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 53-86.
    6. Labadie, Pamela, 1994. "The term structure of interest rates over the business cycle," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 671-697.
    7. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    8. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    9. Rabanal, Pau & Rubio-Ramirez, Juan F., 2005. "Comparing New Keynesian models of the business cycle: A Bayesian approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1151-1166, September.
    10. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-576, June.
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    Cited by:

    1. Aguilar-Argaez Ana María & Elizondo Rocío & Roldán-Peña Jessica, 2016. "Break-Even-Inflation's Decomposition in Mexico," Working Papers 2016-22, Banco de México.

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