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INFLATION AND THE MEAN-REVERTING LEVEL OF THE SHORT RATE

Authors

  • ANDREAS RESCHREITER

    1. Raiffeisen Zentralbank AG
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    •  

      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.


  • Manuscript received 17.10.07; final version received 4.11.08.

Abstract

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.

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