Bills and Inflation 19541999

The Fisher equation predicts a close connection between inflation and the rate of return on T-bills. This is apparent in Figure 5.2, which plots both time series on the same set of axes. Both series tend to move together, which is consistent with our previous statement that expected inflation is a significant force determining the nominal rate of interest.

For a holding period of 30 days, the difference between actual and expected inflation is not large. The 30-day bill rate will adjust rapidly to changes in expected inflation induced by observed changes in actual inflation. It is not surprising that we see nominal rates on bills move roughly in tandem with inflation over time.

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