by Michael D. Bauera
This paper provides new evidence on the importance of inflation expectations for variation in nominal interest rates, based on both market-based and survey-based measures of inflation expectations. Using the information in TIPS break-even rates and inflation swap rates, I document that movements in inflation compensation are important for explaining variation in long-term nominal interest rates, unconditionally as well as conditionally on macroeconomic data surprises. Daily changes in inflation compensation and changes in long-term nominal rates generally display a close statistical relationship. The sensitivity of inflation compensation to macroeconomic data surprises is substantial, and it explains a sizable share of the macro response of nominal rates. The paper also documents that survey expectations of inflation exhibit significant co-movement with variation in nominal interest rates, as well as significant responses to macroeconomic news.
JEL Codes: E43, E44, E52.
Full article (PDF, 40 pages, 796 kb)
a Federal Reserve Bank of San Francisco