The Term Structure of Inflation Expectations

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  • 1 January 2008
    • preprint
      • Published in RePEc
Abstract
Is monetary policy effective? We rely on the evidence from the term structure of inflation expectations implicit in the nominal yields and survey forecasts of inflation to address this question. We construct a model that accommodates forecasts over multiple horizons from multiple surveys and Treasury yields by allowing for differences between risk-neutral, subjective, and objective probability measures. We extract private sector expectations of inflation from this model and document that they are driven by inflation, real activity and only one of the two latent factors, which is correlated with survey forecasts. We show that interest rate responds to this ``survey'' factor. The inflation premium and out-of-sample estimates of the inflation long-run mean and persistence suggest that monetary policy became effective over time. As an implication, our model outperforms a standard macro-finance model in inflation and yield forecasting.

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