Working Papers

March 1997, No. 97-3

The Bond Rate and Actual Future Inflation

Yash P. Mehra

The long-term bond rate is cointegrated with the actual one-period inflation rate during two sample periods, 1961Q1 to 1979Q3 and 1961Q1 to 1995Q4. This result indicates that in the long run the bond rate and actual inflation move together. The nature of short-run dynamic adjustments between these variables has, however, changed over time. In the pre-1979 period, when the bond rate rose above the one-period inflation rate, actual inflation accelerated. In the post-1979 period, however, the bond rate reverted back and actual inflation did not accelerate. Thus, the bond rate signaled future inflation in the period before 1979, but not thereafter. The results here indicate that in the period after 1979 Fed policy prevented any pickup in inflationary expectations (evidenced by the rise in the bond rate) from getting reflected in higher actual future inflation.

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