Core and `Crust': Consumer Prices and the Term Structure of Interest Rates

We estimate a model for nominal and real term structures of interest rates that includes dynamics for the three main components of total inflation: core, food, and energy. These dynamics combine together to produce a measure of expected total inflation that investors use to price nominal Treasuries. This framework captures different frequencies in inflation fluctuations: shocks to core are more persistent and less volatile than shocks to food and, especially, energy (the `crust'). The model fits yields and inflation data well in sample, and produces inflation forecasts that outperform several benchmarks out of sample. A common structure of latent factors explains most of the variance of the forecasting error for core inflation and bond yields. This evidence suggests that interest rates contain useful predictive content for inflation. Moreover, we estimate real interest rates, as well as inflation and real rate risk premia, that are consistent with related market-based measures.