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INFLATION AND THE MEAN‐REVERTING LEVEL OF THE SHORT RATE *
Author(s) -
RESCHREITER ANDREAS
Publication year - 2010
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/j.1467-9957.2009.02129.x
Subject(s) - mean reversion , economics , inflation (cosmology) , econometrics , inflation rate , real interest rate , monetary policy , keynesian economics , physics , theoretical physics
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.