UNIT ROOTS, INTEREST-RATE SPREADS, AND INFLATION-FORECASTS

Recent research suggests that long-term interest rate spreads provide information that can be useful in forecasting inflation, but that the spread between the three-month and six-month Treasury bill rates appea rs to have little forecasting ability. This paper uses the concepts of unit roots and cointegration to examine the failure of the short-term T-bill spread to forecast inflation. The results suggest that the int erest rate spread has little forecasting value because inflation and t he interest rate spread exhibit distinctly different time-series prope rties.