Extracting Deflation Probability Forecasts from Treasury Yields
by Jens H.E. Christensen, Jose A. Lopez, and Glenn D. Rudebusch
Federal Reserve Bank of San Francisco
We construct probability forecasts for episodes of price
deflation (i.e., a falling price level) using yields on nominal
and real U.S. Treasury bonds. The deflation probability forecasts
identify two “deflation scares” during the past decade: a
mild one following the 2001 recession and a more serious one
starting in late 2008 with the deepening of the financial crisis.
The estimated deflation probabilities are generally consistent
with those from macroeconomic models and surveys of professional
forecasters, but they also provide high-frequency insight
into the views of financial market participants. The probabilities
can also be used to price the deflation protection option
embedded in real Treasury bonds.
JEL Codes: E31, E43, G12, G13.
(PDF, 40 pages 615 kb)