Question: The rate of inflation for the coming year is expected
The rate of inflation for the coming year is expected to be 3 percent, and the rate of inflation in Year 2 and thereafter is expected to remain constant at some level above 3 percent. Assume that the real risk-free rate, r*, is 2 percent for all maturities and the expectations theory fully explains the yield curve, so there are no maturity premiums. If three-year Treasury bonds yield 2 percentage points more than one-year bonds, what rate of inflation is expected after Year 1?
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