Chapter 17 - The term structure of expectations

Abstract

Economic theory predicts that intertemporal decisions critically depend on expectations about future outcomes. Using the universe of professional survey forecasts for the U.S., we document the behavior of the entire term structure of expectations for output growth, inflation, and the policy rate. We show that a simple, multivariate unobserved components model of the trend and cycle explains the joint behavior of short- and long-run expectations. Consistent with the data, the model predicts a link between revisions in long-run expectations and short-term forecast errors. We evaluate the expectations hypothesis using the term structure of short-rate forecasts. Despite substantial variation in measured expectations of future short rates at all horizons, a large share of movements in longer-maturity interest rates remains unaccounted for. In structural models, learning about the long run has important empirical and theoretical implications for monetary and fiscal policy.