Inflation Expectations: How the Market Speaks

This reading, "Inflation Expectations: How the Market Speaks" discusses the market for Treasury Inflation Protection Securities (TIPS) and how their yields, appropriately adjusted for inflation risk and liquidity, can be compared to those of conventional Treasury securities to glean information about inflation expectations.

1. Define the following terms used in the reading:
   1. nominal yield
   2. real rate of interest
   3. breakeven inflation rate
   4. inflation risk premium
   5. liquidity premium
   6. Fed's dual mandate

2. Describe the following aspects of TIPS:
   1. How are they sold?
   2. How is their interest rate determined?
   3. What maturities are available?
   4. How do they protect investors against inflation?
   5. How does their liquidity compare to other Treasury securities?

3. In principal, how do TIPS provide a measure of the market's expectations of future inflation?

4. How do the inflation risk premium and the liquidity premium affect the accuracy of the breakeven inflation rate as a measure of inflation expectations?

5. How could TIPS yields help estimate long-term inflation expectations, for example, over a ten-year period beginning ten years from now? Could such an estimate aid in assessing and guiding Fed monetary policy? Explain.

Source: "Inflation Expectations: How the Market Speaks." Simon Kwan, FRBSF Economic Letter 2005-25, Federal Reserve Bank of San Francisco, October 3, 2005.