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Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis that the Real Rate of Interest is Constant
TLDR
In this article, the authors present evidence which appears to be consistent with the joint hypothesis that the real rate of interest, ignoring taxes, is a constant and that the market for U.S. Treasury Bills is efficient in the sense of embodying rational expectations.Abstract:
In an innovative and provocative paper in this Review, Eugene Fama presents evidence which appears to be consistent with the joint hypothesis that the real rate of interest, ignoring taxes, is a constant and that the market for U.S. Treasury Bills is efficient in the sense of embodying rational expectations.' Those findings are strikingly at variance with a long list of previous studies which seemed to support the view that the real rate of interest varies over time and can be related to economic variables such as real output, monetary policy, and so forth.2 The methodologies which lead to these contradictory conclusions are quite different. Previous studies had followed the lead of Irving Fisher by relating nominal interest rates to distributed lags on past rates of inflation.3 These distributed lags are generally interpreted as approximations to the market's expected rate of inflation and thus any remaining variation is attributed to variation in the real rate.4 Fama's methodology, on the other hand, draws on the fact that the difference between the market interest rate and the subsequently observed rate of inflation, the ex post real interest rate, consists by definition of the ex ante real interest rate plus a pure forecasting error.5 The hypothesis of market efficiency implies that these forecasting errors must be serially random. Thus, observing ex post real rates is equivalent to observing ex ante real rates with random measurement error. These errors of course confound the problem of identifying variation in the ex ante real rate. In this paper, we will argue that the relative magnitude of these measurement errors is such that the tests carried out by Fama were not powerful enough to reject the joint hypothesis that the ex ante real rate is a constant and expectations are rational. More powerful tests which are presented in this paper using the same data do lead to rejection of that hypothesis. Of course, rejectionread more
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Asset returns and inflation
TL;DR: In this article, the authors estimate the extent to which various assets were hedges against the expected and unexpected components of the inflation rate during the 1953-1971 period and find that U.S. government bonds and bills were a complete hedge against expected inflation, and private residential real estate was a complete hedging against both expected and expected inflation.
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Tests for Unit Roots: A Monte Carlo Investigation
TL;DR: In particular, the tests developed by Phillips and Perron as mentioned in this paper seem more sensitive to model misspecification than the high-order autoregressive approximation suggested by Said and Dickey (1984, 1985), Phillips (1987), and Phillips and perron (1988).
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The Fiscal and Monetary Linkage between Stock Returns and Inflation
Robert Geske,Richard Roll +1 more
TL;DR: The authors argue that stock returns are negatively related to contemporaneous changes in expected inflation because they signal a chain of events which results in a higher rate of monetary expansion and that this puzzling empirical phenomenon does not indicate causality.
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Why Has U.S. Inflation Become Harder to Forecast
James H. Stock,Mark W. Watson +1 more
TL;DR: The authors examined whether the U.S. rate of price inflation has become harder to forecast and, to the extent that it has, what changes in the inflation process have made it so, and found that the univariate inflation process is well described by an unobserved component trend-cycle model with stochastic volatility or, equivalently, an integrated moving average process with time-varying parameters.
References
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Efficient capital markets: a review of theory and empirical work*
TL;DR: Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene Fama Source: The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417 as mentioned in this paper
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Rational Expectations and the Theory of Price Movements
TL;DR: In this article, the Stockholm School hypothesis is used to explain how expectations are formed in the context of an isolated market with a fixed production lag, and commodity speculation is introduced into the system.
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Inflation and Real Interest
TL;DR: The theory of interest under inflation has been investigated by as mentioned in this paper, who concluded that the money rate of interest rises by the anticipated rate of inflation or falls by the expected rate of deflation.