This paper exploits the term structure of interest rates to develop testabl
e economic restrictions on the joint process of long-term interest rates an
d inflation when the latter is subject to a targeting policy by the central
bank. In an empirical application to the Canadian inflation target zone, r
esults indicate that financial markets perceive the band to be of approxima
tely the same width as announced but asymmetrically distributed around the
official target. This finding suggests that, in practice, the monetary auth
ority might attach different weights to positive and negative inflation dev
iations from the target. Copyright (C) 2000 John Wiley & Sons, Ltd.