Sunday, August 11, 2013

Expected Inflation and Treasury Bond Yields

Below, we plot the Treasury bond yields against the Cleveland Fed's estimates of expected inflation (click to enlarge).  It is important to note that the Cleveland Fed's estimates may be a noisy measure of "true" expected inflation.
A simple model in finance would suggest a one-to-one correlation between expected inflation and interest rates.  More complex models may deviate from this.  For example, they may allow for pricing of uncertainty about inflation (and therefore an inflation risk premium) that correlates with the level of inflation.

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