Inflation indexed bonds and monetary theory

Summary. The introduction of inflation indexed bonds, or “tips” - treasury inflation protected securities, provides important new data for analyzing the state of the economy and for assessing the validity and significance of macroeconomic theories. This note will show that tip yields contain information for predicting real variables. Furthermore, the inclusion of tip yields supersedes the role of nominal variables - both the ten year nominal bond and fed funds rate - for incrementally predicting (Granger causing) real variables. The data support the notion of block exogeneity - the lack of feedback from nominal to real variables. This result would appear to be inconsistent with the idea that monetary policy, as implemented through changes in the fed funds rate, has had measurable real effects over this, admittedly brief, sample (See for example Christiano, Eichenbaum, and Evans (1998) who argue that the impulse response functions to fed fund shocks can be used to estimate the response to unanticipated policy shocks. However they find that these have not been a major source of output fluctuations. The present study implies that such inferences are not robust to the introduction of tip yields). Received: 7 August 2004, Revised: 19 December 2004 JEL Classification Numbers: E01, E04, E05.Laurence Weiss: I thank Bob Litterman and Bob Lucas for discussion and inspiration.