• August 11, 1996

    Real short-term interest rates and expected inflation: Measurement and interpretation

    This article compares different measures of real short-term interest rates for Canada over the period from 1956 to 1995. A new measure for the expected real interest rate is constructed using a proxy for inflation expectations that is based on the properties of past inflation. The history of inflation in Canada suggests that the characteristics of inflation have changed considerably over time. Past inflation can be characterized by three different types of behaviour: an environment in which average inflation is low and shocks to inflation have only temporary effects; an environment of moderate inflation with more persistent disturbances; and an environment of drifting inflation in which shocks have permanent effects on the level of inflation. The proxy for inflation expectations uses a statistical model, called a Markov Switching Model, to take account of changes in the behaviour of inflation over time. It is found that uncertainty about the changing characteristics of inflation behaviour leads to uncertainty about estimates of inflation expectations and thus about measures of real interest rates. Target ranges for keeping inflation low should help reduce the uncertainty about inflation behaviour. The behaviour of inflation and interest rates suggests that the credibility of the Bank of Canada's inflation-control objectives is growing. This should reduce inflation uncertainty and lead to lower nominal interest rates over time.
  • August 11, 1996

    Bank of Canada Review - Summer 1996

    BoC Review - Summer 1996/Revue BdC - Été 1996

    Cover page

    Home savings bank: The Northern Bank

    The savings bank shown here was issued to account holder 1859 by the Victoria, B.C. branch. It is part of the National Currency Collection, Bank of Canada.

    Photography by James Zagon.

  • August 10, 1996

    Inflation expectations and Real Return Bonds

    The existence of a market for Real Return Bonds in Canada provides a direct tool with which to measure market expectations of inflation by comparing the yields on these bonds with those on conventional Government of Canada long-term bonds. However, there are other factors besides inflation expectations that may affect the yield differential. After reviewing these factors, the authors note that they can lead to a potentially large bias in the level of inflation expectations. The changes in the differential over time may, nonetheless, be a good indicator of movements in long-run inflation expectations. Based on this measure, expectations of long-run inflation have declined since late 1994.
  • Avoiding the Pitfalls: Can Regime-Switching Tests Detect Bubbles?

    Staff Working Paper 1996-11 Simon van Norden, Robert Vigfusson
    Work on testing for bubbles has caused much debate, much of which has focussed on methodology. Monte Carlo simulations reported in Evans (1991) showed that standard tests for unit roots and cointegration frequently reject the presence of bubbles even when such bubbles are present by construction. Evans referred to this problem as the pitfall of testing for bubbles.
    Content Type(s): Staff Research, Staff Working Papers Topic(s): Econometric and statistical methods JEL Code(s): C, C2, C22, C5, C52
  • Unit-Root Tests and Excess Returns

    Staff Working Paper 1996-10 Marie-Josée Godbout, Simon van Norden
    Several recent papers have presented evidence from foreign exchange and other markets suggesting that the log of excess returns can be characterized as first-order integrated processes (I(1)). This contrasts sharply with the "conventional" wisdom that log prices are integrated of order one I(1) and that log returns should therefore be integrated of order zero I(0), and even more sharply with the view that past returns have no ability to predict future returns (weak market efficiency).
    Content Type(s): Staff Research, Staff Working Papers Topic(s): Econometric and statistical methods JEL Code(s): C, C1, C12, F, F3, F31
  • Does Inflation Uncertainty Vary with the Level of Inflation?

    Staff Working Paper 1996-9 Allan Crawford, Marcel Kasumovich
    The purpose of this study is to test the hypothesis that inflation uncertainty increases at higher levels of inflation. Our analysis is based on the generalized autoregressive conditional heteroscedasticity (GARCH) class of models, which allow the conditional variance of the error term to be time-varying. Since this variance is a proxy for inflation uncertainty, a positive relationship between the conditional variance and inflation would be interpreted as evidence that inflation uncertainty increases with the level of inflation.

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