Information Content in the Term Structure of Money Market Interest Rates on Future Inflation : The Case of Finland

Using a Markov-switching regime change model applied to Finnish money market interest spreads we find that unobserved changes from tightening to loosening monetary policy are important when examining the explanatory power of interest rates on future inflation changes. The unobserved regime changes are revealed ex ante (3 - 4 months ahead) with respect to observed changes in a recently introduced measure for the stance of monetary policy, i.e. the Monetary Conditions Index (MCI). Implementing the derived monetary policy regime changes to the analysis does not increase the forecasting power of interest rate spreads on future inflation changes, but the monetary policy regime itself explains changes in the future inflation rates strongly