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Chapter 5

1 Why is the interest rate on a credit card usually higher than the interest rate on an automobile loan ?

4 Explain what a yield curve shows. What must be held constant among the bonds whose interest rates are shown on a yield curve?

7 What is a term premium, and why does it exist?

Chapter 6

2 Describetheoverallmovementsofshort-and long-term real interest rates over the past 30 years. Are real interest rates roughly constant over time?

and one more

Chapter 5 1 Why is the interest rate on a credit card usually higher than the interest rate on an automobile loan ? 4 Explain what a yield curve shows. What must be held constant among the bonds whose interest rates are shown on a yield curve? 7 What is a term premium, and why does it exist? Chapter 6 2 Describetheoverallmovementsofshort-and long-term real interest rates over the past 30 years. Are real interest rates roughly constant over time?
Search Site Home > Publications > Regional Economist > April 2016 > In ation Expectations Are Important to Central Bankers, Too PRINT FRIENDLY VERSION DOWNLOAD PDF By James Bullard Modern economic theory says that in ation expectations are an important determinant of actual in ation. How does expected in ation affect actual in ation? Firms and households take into account the expected rate of in ation when making economic decisions, such as wage contract negotiations or rms’ pricing decisions. All of these decisions, in turn, feed into the actual rate of increase in prices. Given that central banks are concerned with price stability, policymakers pay attention to in ation Subscribe Get noti ed when the latest Regional Economist article is published. expectations in addition to actual in ation. The two main ways to gauge in ation expectations are survey-based measures and market-based measures. An example of the former is the in ation expectations from the University of Michigan’s survey of consumers. As a predictor of in ation, this measure tends to overstate in ation. Over the past 10 years, for example, expected in ation one year ahead averaged more than 3 percent, while actual in ation ended up averaging less than 2 percent. The Michigan survey’s results also tend to bounce around quite a bit with the price of gasoline. Because consumers usually go to the gas station, as well as the grocery store, on a weekly basis, changes in those prices strongly shape their in ation expectations. However, many other prices exist in the economy, perhaps making this particular way of looking at in ation expectations less useful.1 Another example of a survey-based measure comes from the Survey of Professional Forecasters (SPF), a group that tracks the economy extremely closely. The SPF provides forecasts of in ation based on the consumer price index (CPI) and on the personal consumption expenditures price index (PCE). The group’s expectations of PCE in ation, which is the in ation measure that the Fed targets, are consistently around the Fed’s target of 2 percent. One interpretation of these forecasts is that these professional forecasters have con dence that the Fed will make sure in ation is 2 percent no matter what is going on in the economy. This could be good from the central bank’s perspective because the forecasts are signaling Fed credibility with respect to its stated in ation target. On the other hand, the forecasts might not be very useful because they do not provide much guidance on what the central bank would have to do to steer in ation to 2 percent. Although many people focus on survey-based measures, I tend to put more weight on market-based measures of in ation expectations. These are tied to the market for Treasury In ation-Protected Securities (TIPS) and are based on CPI in ation. The basic idea is that a nominal security, such as a Treasury note, and a real (or in ationadjusted) security with the same maturity both trade in the market. The price difference between the two could be interpreted as the market participants’ expectation of Subscribe Keep up with what’s new and noteworthy at the St. Louis Fed. Sign up now to have this free monthly e‑newsletter emailed to you. in ation over the horizon of the security; this difference is also called the breakeven in ation rate. TIPS-based measures of in ation expectations are available, for instance, at ve-year and 10-year horizons, as well as a “ ve-year, ve-year forward” horizon, which re ects expectations of in ation not in the next ve years but in the ve years after that. The TIPS-based measures may be viewed as more informative than survey-based measures because the former tend to react more to incoming information about the Tweets by @stlouisfed St. Louis Fed @stlouisfed Job separations (including quits, layoffs and discharges) rose by 86,000 in April to 5.408 million #JOLTS economy than do the latter. In this sense, the TIPS-based measures of in ation expectations give a better sense of shifting in ation expectations than do other measures. One caveat to this view is that TIPS spreads also re ect differences in the liquidity and risk characteristics of nominal and real securities, and that it may be premia associated with liquidity and risk that are responding to incoming data, as opposed to in ation expectations themselves.2 I do not nd those analyses very compelling. Consequently, I think market-based TIPS spreads provide the best measure of in ation expectations.3 51m St. Louis Fed @stlouisfed Ideally, all of these measures of in ation expectations would be close to the Fed’s The latest Central Banker newsletter is out. Browse the new edition and target of 2 percent—or 2.3 percent for those that refer to CPI in ation, which tends to run about 30 basis points higher than PCE in ation. However, in ation expectations in sign up to get the next one major in ation-targeting economies have not been running close to target of late. Europe is a prime example where in ation expectations fell dramatically in recent years. The European Central Bank subsequently took extraordinary action to try to return News and upda… in ation to target by implementing a quantitative easing program. In the U.S., TIPSbased measures of in ation expectations have fallen since the summer of 2014 and are somewhat below levels that would be consistent with a PCE in ation rate of 2 percent.4 Whether the Fed’s policies will be su cient to return these expectations to more normal levels remains to be seen. 1h St. Louis Fed @stlouisfed Job openings in the U.S. edged up 65,000 in April to 6.698 million, a new series high #JOLTS Endnotes 1. The New York Fed’s Survey of Consumer Expectations also provides a measure of consumers’ expectations for in ation. See [back to text] 2. For instance, see Gospodinov, Nikolay; Tkac, Paula; and Wei, Bin. “Are Long-Term In ation Expectations Declining? Not So Fast, Says Atlanta Fed,” Macroblog, Jan. 15, 2016. Also see Bauer, Michael D.; and McCarthy, Erin. “Can We Rely on Market-Based In ation Forecasts?” FRBSF Economic Letter 2015-30, Sept. 21, 2015. [back to text] 3. Another market-based measure of in ation expectations is so-called in ation swaps. For a discussion of TIPS breakeven rates and in ation swaps, see Lucca, David; and Schaumburg, Ernst. “What to Make of Market Measures of In ation Expectations?” Liberty Street Economics, New York Fed, Aug. 15, 2011. [back to text] 4. The drop since 2014 has been highly correlated with oil prices. For more on this topic, see my presentation on Feb. 24, 2016, “More on the Changing Imperatives for U.S. Monetary Policy Normalization.” [back to text] ABOUT THE AUTHOR James Bullard James Bullard is president and CEO of the Federal Reserve Bank of St. Louis. In this capacity, he oversees the activities of the Eighth Federal Reserve District and is a participant on the Federal Reserve’s Federal Open Market Committee, or FOMC, which sets the direction of U.S. monetary policy. See more from President Bullard. Previous Article China's Rapid Rise: From Backward Agrarian Society to Industrial ... View Commenting Policy Next Article Interest Rate Control Is More Complicated Than You Thought 2h
Econ 3571: Money & Banking Pre-Class Homework 1 10 Points Total -Read all of Chapter 5 and answer Review Questions 1, 4, 7 -Read Chapter 6, sections 6-1 and 6-3 and answer Review Question 2 -Read the article Inflation Expectations Are Important to Central Bankers, Too and answer the following question: -Does the author of the article (James Bullard) prefer survey-based measures of expected inflation or market-based measures of expected inflation? (Note that the “Review Questions” are found at the end of the chapter in the M&B3 textbook)

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