TY  - JOUR
AU  - Lewis,Karen K.
AU  - Evans,Martin D.
TI  - Do Expected Shifts in Inflation Policy Affect Real Rates?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 4134
PY  - 1992
Y2  - August 1992
UR  - http://www.nber.org/papers/w4134
L1  - http://www.nber.org/papers/w4134.pdf
N1  - Author contact info:
Karen K. Lewis
Department of Finance, Wharton School
2300 SHDH
University of Pennsylvania
Philadelphia, PA 19104-6367
Tel: 215/898-7637
Fax: 215/898-6200
E-Mail: lewisk@wharton.upenn.edu

Martin Evans
Department of Economics
Georgetown University
Washington, DC  20057
Tel: 202-687-1570
E-Mail: evansm1@georgetown.edu
AB  - This paper presents a new explanation for the negative correlation between ex post real interest rates and inflation found in earlier empirical studies. We begin by showing that there is a strong negative correlation between the permanent movements in ex post real interest rates and inflation. We argue that such a correlation can arise when people incorporate anticipated shifts in inflation policy into their expectations. Under these circumstances, a shift to lower (higher) inflation will lead to systematically higher (lower) ex post real rates. Using new time series techniques we are able to reject the hypothesis that nominal interest rates were unaffected by anticipated switches in inflation policy in the post-war era. To evaluate the impact of these switches, we then calculate the effects of inflationary expectations upon real rates using a Markov switching model of inflation. Inflation forecasts based upon the estimates of this rational model behave similarly to inflation forecasts from the Livingston survey. When ex ante real interest rates are identified with the Markov models of inflation, we find that ex ante real interest rate does not contain permanent shocks, nor is it related to permanent shocks in inflation.
ER  -