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The Term Structure of Inflation Compensation in the Nominal Yield Curve


We propose a DSGE model with regime switching in the central bank’s inflation target to explain inflation compensation in the UK. Taking advantage of the well-documented change in UK monetary policy to adopt inflation targeting, we estimate our model using nominal and inflation-linked Treasury bond data from the UK from 1985 to 2007. We find that this model can account for the term structure of inflation compensation in the nominal yield curve by generating regime-dependent conditional expectations of future inflation.

JEL Codes: E31, E43, E52, G12

Keywords: Term structure of interest rates, real yield curve, inflation risk premia, regime-switching DSGE model, Bayesian estimation, inflation target


Suggested citation: Pasaogullari, Mehmet, and Simeon Tsonev, 2011. “The Term Structure of Inflation Compensation in the Nominal Yield Curve,” Federal Reserve Bank of Cleveland, Working Paper no. 11-33.

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