An Indicator of Future Inflation Extracted From the Steepness of the Interest Rate Yield Curve Along Its Entire Length

Jeffrey Frankel and Cara S. Lown

No 3751, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: It is often suggested that the slope of the term structure of interest rates contains information about the expected future path of inflation. Mishkin (1990) has recently shown that the spread between the 12-month and 3-month interest rates helps to predict the difference between the 12-month and 3-month inflation rates. His approach however, lacks a theoretical foundation, other than the (rejected) hypothesis that the real interest rate is constant. This paper applies a simple existing theoretical framework, which allows the real interest rate to vary in the short run but converge to a constant in the long run, to the problem of predicting the inflation spread. It is shown that the appropriate indicator of expected inflation can make use of the entire length of the yield curve, in particular by estimating the steepness of a specific nonlinear transformation of the curve, rather than being restricted to a spread between two points. The resulting indicator, besides having a firmer theoretical foundation does a relatively good job of predicting the inflation rate over the period 1960 to 1988.

Date: 1991-06
Note: ME
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Citations: View citations in EconPapers (7)

Published as Quarterly Journal of Economics, May 1994, pp. 517-530

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Related works:
Journal Article: An Indicator of Future Inflation Extracted from the Steepness of the Interest Rate Yield Curve Along Its Entire Length (1994)
Working Paper: An indicator of future inflation extracted from the steepness of the interest rate yield curve along its entire length (1991)
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