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Economic Quarterly

Spring 1998

The Bond Rate and Actual Future Inflation

Yash P. Mehra

In the sample periods studied here, the bond rate and actual inflation move together. However, ways in which they have adjusted to each other in the short run have changed since 1979. In the pre-1979 period, when the bond rate rose above the current inflation rate, actual future inflation accelerated. In the post-1979 period, however, the rise in the bond rate was reversed and actual future inflation did not accelerate. The bond rate thus signaled acceleration in future inflation before 1979 but not thereafter. The Fed's disinflationary policy in force since 1979 may have prevented rises in inflationary expectations from getting embodied in higher actual future inflation rates. Such Fed behavior may have reduced the usefulness of the bond rate as a precursor of actual future inflation.

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