Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/241172 
Year of Publication: 
2020
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2020-6
Publisher: 
Bank of Canada, Ottawa
Abstract: 
We propose a portfolio-balance model of the yield curve in which inflation is determined through an interest rate rule that satisfies the Taylor principle. Because arbitrageurs care about their real wealth, they only absorb an increase in the supply of nominal bonds if they are compensated with an increase in their real rates of return. At the same time, because the Taylor principle implies that short-term nominal rates are adjusted more than one for one in response to changes in inflation, the real return on nominal bonds depends positively on inflation. In equilibrium, inflation increases when there is an increase in the supply of nominal bonds to compensate arbitrageurs for the additional supply they have to hold.
Subjects: 
Asset pricing
Debt management
Inflation and prices
Interest rates
Monetarypolicy
JEL: 
E43
E52
G12
H63
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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