A Technique for Extracting a Measure of Expected Inflation from the Interest Rate Term Structure

Abstract

Few macroeconomic variables are as curcial to so many current controversies, and yet as hard to measure in empirical work, as the expected inflation rate. Each of the proxies which are often used for the expected inflation rate has serious drawbacks. Public opinion survey data are not based on observed economic behavior. Lagged values of the actual inflation rate, or other relevant macroeconomic variables cannot hope to capture all the information that enters into formation of expectations (for example, the atest government accouncements of money growth). Future values of the actural inflation rate differ from the expected inflation rate by large expectational errors (even though they have mean zero if expectations are rational).