Real interest rate = Nominal rate - Expected inflation
In the above equation, in a quarterly data-set, which expected inflation shall be used? next quarter (q+1) or the same quarter of next year (q+4)? and why?
Economics Stack Exchange is a question and answer site for those who study, teach, research and apply economics and econometrics. It only takes a minute to sign up.Sign up to join this community
It is the expected inflation rate over the life of the instrument. So if it is a 10-year bond, it is expected inflation over the next 10 years.
If you use future values of the price index to determine “expected” inflation, you are assuming bond investors can predict the future perfectly. Based on my experience, that assumption is implausible. It could be justified, but one would really need to be careful about how the data are interpreted.