Nominal rates, real rates, and expected inflation: Results from a study of U.S. Treasury Inflation-Protected Securities

This paper studies U.S. Government issued inflation-indexed bonds, known by the acronym TIPS (Treasury Inflation-Protected Securities). We test whether changes in nominal interest rates are related to changes in expected inflation, and we also examine the duration of TIPS bonds relative to the duration of ordinary (nominal) Treasury bonds. In addition, we present evidence of the accuracy of the inflation estimates generated using a pricing algorithm. The results of the paper indicate that changes in nominal interest rates are significantly related to changes in expected inflation; that the hypothesis that nominal interest rates adjust on a one-for-one basis with the change in expected inflation cannot be rejected; and, that investors systematically underestimated the rate of inflation in their pricing of TIPS bonds for the time period of the study.