Disagreement about Inflation and the Yield Curve
BI - Norwegian Business School
Michael F. Gallmeyer
University of Virginia (UVA) - McIntire School of Commerce
London Business School - Department of Finance
Philipp K. Illeditsch
University of Pennsylvania - Finance Department
February 1, 2016
We show that inflation disagreement, not just expected inflation, has a first-order effect on nominal interest rates. In contrast to expected inflation, which mainly affects the wedge between real and nominal yields, inflation disagreement affects nominal yields predominantly through its impact on the real side of the economy. We show theoretically and empirically that inflation disagreement raises real and nominal yields and their volatilities. Inflation disagreement is positively related to consumers' cross-sectional consumption growth volatility and trading in fixed income securities. Calibrating our model to disagreement, inflation, and yields reproduces the economically significant impact of inflation disagreement on yield curves.
Number of Pages in PDF File: 96
Keywords: Inflation disagreement, relative entropy, real and nominal yields, yield volatilities, cross-sectional consumption growth volatility, trading on inflation beliefs
JEL Classification: D51, E43, E52, G12
Date posted: March 26, 2012 ; Last revised: February 15, 2016
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