FORECASTING INFLATION FROM THE TERM STRUCTURE

Paper number: 95/19

Year: 1995

Paper Category: Discussion Paper

Authors

Elias Tzavalis
Department of Economics
University of Exeter
Exeter EX4 4RJ, UK

M.R. Wickens*
Department of Economics
University of York
Your YO1 5DD, UK

Abstract

This paper presents new evidence about the information contained in the term structure about future inflation. Although the general finding in the literature is that the greater the time horizon the more information the term structure possesses about inflation, in this paper we show that the forecasting ability of the term spread is very poor. The main finding of the paper is that the real interest rate contains far more information about future inflation that the term spread.

JEL Classification numbers: C32, C52, E43.
Key words:: Fisher equation; term structure; rational expectations; cointegration; Vector Error Correction Model.

*The authors greatly acknowledge the two anonymous referees. Financial support for this research by the ESRC under grant R00232696 is also acknowledged.