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Monetary Policy, Expected Inflation, and Inflation Risk Premium

  • Juha Seppala

    (University of Illinois)

  • Federico Ravenna

    (University of California)

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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Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 513.

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Date of creation: 2007
Date of revision:
Handle: RePEc:red:sed007:513
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Andrew Ang & Geert Bekaert, 2004. "The term structure of real rates and expected inflation," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  3. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  4. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  5. Pamela Labadie, 1991. "The term structure of interest rates over the business cycle," Finance and Economics Discussion Series 159, Board of Governors of the Federal Reserve System (U.S.).
  6. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, December.
  7. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  8. 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.
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