Forecasting Inflation from the Term Structure: A Comparison of Alternative Specifications

Several authors have shown that there exists a significant relationship between the term structure of interest rates and future changes in the rate of inflation. More recently, this relationship has been strengthened through the introduction of nonlinearities and regime shifts. This paper compares these alternative specifications to the original linear model in an out-of-sample forecasting exercise. We find that three-regime models that allow for shifts in the inflation risk premium or real interest rate (or both) are the most promising forecasting models of inflation when using the term structure.