Uncovering financial markets' beliefs about inflation targets

This paper exploits the term structure of interest rates to develop testable economic restrictions on the joint process of long‐term interest rates and inflation when the latter is subject to a targeting policy by the central bank. In an empirical application to the Canadian inflation target zone, results indicate that financial markets perceive the band to be of approximately the same width as announced but asymmetrically distributed around the official target. This finding suggests that, in practice, the monetary authority might attach different weights to positive and negative inflation deviations from the target. Copyright © 2000 John Wiley & Sons, Ltd.