DP1313 Forward Interest Rates as Indicators of Inflation Expectations

Author(s): Paul Söderlind
Publication Date: December 1995
Keyword(s): Forward Rates, Inflation Expectations, Real Interest Rates
JEL(s): E31, E43, E44, G12
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1313

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.