I thank two anonymous referees, Antonio Mele, Gabe Lee, Ben Nowman, Stefan Pichler and seminar participants at Westminster Business School and the Austrian Working Group in Finance for comments. The usual disclaimer applies.
INFLATION AND THE MEAN-REVERTING LEVEL OF THE SHORT RATE*
Article first published online: 23 DEC 2009
© 2009 The Author. Journal compilation © 2009 Blackwell Publishing Ltd and The University of Manchester
The Manchester School
Volume 78, Issue 1, pages 76–91, January 2010
How to Cite
RESCHREITER, A. (2010), INFLATION AND THE MEAN-REVERTING LEVEL OF THE SHORT RATE. The Manchester School, 78: 76–91. doi: 10.1111/j.1467-9957.2009.02129.x
Manuscript received 17.10.07; final version received 4.11.08.
- Issue published online: 23 DEC 2009
- Article first published online: 23 DEC 2009
In this paper we investigate whether inflation causes the time-varying mean-reverting level in the Balduzzi et al. (Review of Economics and Statistics, Vol. 80, No. 1 (1998), pp. 62–72) short rate model. We find a time-varying mean-reverting level for the UK nominal short rate, but the real short rate mean reverts to a constant. This suggests a monetary source for the time-varying mean-reverting level in nominal short rate models. The time-varying mean factor is closely related to market expectations about future inflation. This suggests that expected future inflation determines the mean-reverting level of the nominal short rate.