On the Econometrics of Predicting Inflation from the Nominal Interest Rate

Jean A. Crockett

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: The problems of aggregating divergent individual forecasts of inflation, each subject to error on a number of grounds, into a "market forecast" are considered; and it is shown to be extremely unlikely that such an aggregate will always reproduce precisely the optimal forecast based on all relevant prior events, whether or not these are accurately observable. If this is not the case, then regressions relating the inflation rate to prior values of the nominal interest rate generate parameter estimates that are subject to bias, even if the real rate is constant. Inferences based on those parameter estimates are likely to be invalid.

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