A Model for Ex Ante Real Interest Rates and Derived Inflation Forecasts
Abstract A methodology for estimating expected real interest rates and making inflation forecasts, together with appropriate confidence intervals, is presented. The role of price expectations in determining real interest rates is also analyzed. Structural breaks in the process generating real interest rates are detected in 1980 and 1983 by tracking the accuracy of interest-rate forecasts. Analysis of these structural breaks reveals that the break at the beginning of 1983 returns the process to its pre-1980 formulation. During 1953-1985, price forecasts derived from the interest-rate model are found to be unbiased once the structural breaks in the real rate process are handled through heteroscedastic corrections. Invoking the rational-expectations hypothesis, we construct a general yet parsimonious dynamic model for estimating economic agents' anticipations of the real rate of interest. By using quarterly data for 1953-1985 the model is efficiently estimated by two-step two-stage least squares. Results pro...