Long-Term Interest Rates and Inflation: A Fisherian Approach.” Federal Reserve Bank of Richmond Economic Quarterly 82

n recentyears,FederalReserve(Fed)policymakershavecometo rely on long-termbondyieldsto measurethepublic’slong-terminflationary expectations.Thelong-termbondrateplaysacentralrolein Goodfriend’s (1993)narrativeaccountof Fed behavior,1979–1992,whichlinks policy-relatedmovementsinthefederalfundsratetochangesintheyieldonlong-term U.S.Treasurybonds.AccordingtoGoodfriend,Fedofficialsinterpretedrapid increasesin long-termbondratesastheproductof risinginflationaryexpecta-tions,reflectingadeteriorationi thecredibilityof theirfightagainstinflation. To restorethatcredibility,theyrespondedbytighteningmonetarypolicy,that is, by raisingthefederalfundsrate.Mehra(1995)presentstatisticalresults thatsupportGoodfriend’sview.Usinganeconometricmodel,hedemonstrates thatchangesin long-termbondrateshelpexplainmovementsin thefederal fundsrateduringthe1980s. Whilethesestudiesprovideconvincingevidenceof a link betweenFed policyandlong-termbondrates,bothstartwiththeuntestedhypothesisthat movementsin suchratesprimarilyreflectchangesin long-terminflationary expectations.And whileeconomictheorydoesidentifyexpectedinflationas onedeterminantof nominalbondyields,it suggeststhatthereareotherde-terminantsaswell.Usingtheoryasa guide,thisarticleseeksto measurethe contributioneachdeterminantmakesin accountingfor movementsin long-termbondyields.By doingso,it attemptsto judgetheextento whichFed policymakersarejustifiedinusingthesebondyieldsasindicatorsof inflationary expectations. TheauthorthanksBobHetzel,TomHumphrey,YashMehra,andStaceySchreftforhelpful commentsandsuggestions.Theopinionsexpressedhereinaretheauthor’sanddonotnec-essarilyrepresentthoseof theFederalReserveBankof Richmondor theFederalReserv