What does consumption tell us about inflation expectations and real interest rates?

Series: Working Papers. 9633.

Author: Juan Ayuso and J. David López-Salido.

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What does consumption tell us about inflation expectations and real interest rates? (2 MB)

Abstract

We estimate real interest rates, bounds on inflation expectations and inflation risk premia in a CCAPM framework under (four) different preference specifications. Given consumption patterns in Spain between 1979 and 1995, real interest rates below 4% can only be obtained if, given a small degree of relative risk aversion, we accept a relatively high degree of patience, an extremely high degree of intertemporal substitution or the existence of some degree of altruism in Spanish household preferences. Inflation risk premium terms are constant and small. Finally, inflation expectations react to movements in inflation trend though with some delay. Thus, agents seem to need "some" time to believe that a new inflation pattern reflects a permanent change. These last two results are robust to the choice of household preferences.