Working Paper: CEPR ID: DP1313
Authors: Paul Söderlind
Abstract: Forward interest rates have become popular indicators of inflation expectations. The usefulness of this indicator depends on the relative volatility and the correlation of inflation expectations and expected real interest rates. This paper studies US and UK data, using a range of different tools and data sets. The forward rate rule performs reasonably well, in spite of significant movements in the expected real interest rate. The reason is that the 'noise' that movements in the expected real interest rate add to the inflation expectations is balanced by a tendency for expected real interest rates and inflation expectations to move in opposite directions.
Keywords: inflation expectations; real interest rates; forward rates
JEL Codes: E31; E43; E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Nominal forward interest rate (E43) | Inflation expectations (E31) |
| Inflation expectations (E31) | Real interest rates (E43) |
| Real interest rates (E43) | Nominal forward interest rate (E43) |
| Inflation expectations (E31) | Nominal forward interest rate (E43) |
| Real interest rate volatility (E43) | Relationship between nominal forward interest rate and inflation expectations (E43) |