Long-Term Interest Rates and Inflation

University of Piraeus Department of Banking and Finance Working Paper

43 Pages Posted: 23 Jun 2003

See all articles by Dimitrios Malliaropulos

Dimitrios Malliaropulos

University of Piraeus - Department of Banking and Financial Management; National Bank of Greece

Date Written: February 2003

Abstract

In this paper we analyse the relationship between long bond yields and inflation in an economy subject to three types of stochastic disturbances: real shocks, nominal shocks, and shocks to term premia. Statistical inference is based on the impulse-response function of a Structural VAR model, where appropriate long-run identifying restrictions are derived from economic theory. Using data for the U.S. over the past 45 years, we find that long bond yields and inflation move one-for-one both in the medium term and in the long term when the economy is subject to real or nominal shocks. However, the predictive power of long bond yields for future inflation breaks down when bond yields are driven by changes in term premia. Given that term premia are related to interest rate volatility, our results help explain the negative correlation between long bond yields and inflation during the 1980s, when interest rate volatility climbed to historical peaks.

Keywords: Fisher Effect, VAR, Expectations Hypothesis, Consumption CAPM

JEL Classification: E43, E44

Suggested Citation

Malliaropulos, Dimitrios, Long-Term Interest Rates and Inflation (February 2003). University of Piraeus Department of Banking and Finance Working Paper, Available at SSRN: https://ssrn.com/abstract=385700 or http://dx.doi.org/10.2139/ssrn.385700

Dimitrios Malliaropulos (Contact Author)

University of Piraeus - Department of Banking and Financial Management ( email )

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(+30) 210 3341702 (Fax)

National Bank of Greece ( email )

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