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The Term Structure of Interest Rates and Inflation Forecast Targeting
Eijffinger,S.C.W. Schaling,E. Verhagen,W.H.
Eijffinger,S.C.W.
Schaling,E.
Verhagen,W.H.
Abstract
This paper examines the implications of the expectations theory of the term structure for the implementation of inflation targeting. We show that the term structure weakens the transmission of short term interest rates to ultimate policy objectives. Therefore, short term interest rates in the central bank's forward looking monetary policy rule need to respond more strongly to the output gap and deviations of inflation from its target. Thus, in general the term structure implies a higher degree of policy activism. Next, we show that both the sensitivity of the term spread to economic fundamentals, and the extent to which the spread predicts future output, are increasing in the duration of the long bond and the degree of structural output persistence. If the central bank becomes relatively less concerned about inflation stabilisation the term spread becomes less sensitive to fundamentals, and the spread will be less successful in predicting real economic activity.
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Pagination: 23
Date
1998
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Publisher
Macroeconomics
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85.pdf
Adobe PDF, 113.23 KB
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Keywords
term structure of interest rates, inflation targets, E43 - Interest Rates: Determination, Term Structure, and Effects, E58 - Central Banks and Their Policies
Citation
Eijffinger, S C W, Schaling, E & Verhagen, W H 1998 'The Term Structure of Interest Rates and Inflation Forecast Targeting' CentER Discussion Paper, vol. 1998-85, Macroeconomics, Tilburg.
License
info:eu-repo/semantics/restrictedAccess