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Central banks typically rely on a broad variety of indicators of current and expected future macroeconomic conditions, in particular of output and prices, in order to pursue monetary policy. With the introduction of formal inflation targets in a number of countries – including Australia, Canada, Finland, New Zealand, Spain, Sweden and the United Kingdom – central banks have felt an increasing need to monitor the private sector's price expectations. This can be achieved in at least two ways. One method is to use survey measures of inflation expectations. An alternative way of assessing the private sector's inflation expectations involves extracting estimates of expected future inflation rates from interest rates. A number of central banks have recently begun to use changes in the term structure of forward interest rates as indicators of financial markets' expectations about future economic conditions. In Discussion Paper No. 1264, Research Fellow Stefan Gerlach studies the usefulness of spreads between interest rates of different maturities as indicators of future inflation and real interest rates in Germany, using monthly data from the first quarter of 1967. The central results are two-fold. First, the interest rate spreads considered contain considerable information about future changes in inflation, but no information about the time path of real interest rates. Second, the medium-term segment of the yield curve (spreads between six- and two-year rates, for instance) appears to be the most informative for future inflation. These results are similar to those obtained by Mishkin (1990b) and Jorion and Mishkin (1991). The Information Content of the Term Structure: Evidence for Germany |