Abstract: Inflation and Real Interest Rates
Mentor: Dr. David Eagle, Business
On January 29th, 1997, the United States began issuing Treasury inflation-price securities. Great Britain has issued inflation indexed guilts since 1981. This paper investigates the contracted real rates from Great Britain's inflation-indexed guilts. The ex-ante approach to real interest rates is different than derived real interest rates. Historically, real interest rates have been measured ex-post or looking into the past. The purpose of this paper is to examine the different ways to calculate real interest rates. Historically, literature supports a negative correlation between inflation and real interest rates. However, we find the contracted ex-ante real interest rates is positively correlated with inflation.
Research on contracted real interest rates has mostly been limited to Israel and Great Britain. Countries similar to Israel issue inflation-index securities however, the hyper-inflationary conditions do not make a good prototype for comparing to industrialize nations. This paper assumes the monetary policies are similar between Great Britain and the United States. This paper investigates why inflation-index bonds bear a contracted real interest rate different from derived real interest rates. By studying the components of the real interest rates of inflation-index securities we can identify the reason.
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