Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 594: Forward Interest Rates as Indicators of Inflation Expectations

Paul Söderlind ()
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Paul Söderlind: Stockholm School of Economics, Postal: Stockholm School of Economics, Box 6501, S-113 83 Stockholm

Abstract: Forward interest rates have become popular indicators of inflation expectations. The usefulness of this indicator depends on the relative volatilty and the correlation of inflation expectations and expected real interest rates. This paper studies U.S. and U.K. data, using a range of different tools and data sets. The forward rate rule perfoms 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

28 pages, October 31, 1997

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