The analysis begins by using arbitrage principles to set out some basic relationships between the domestic interest rate, the exchange rate and the

expected rate of inflation.

1] is the retirement income to be received at the end of the first year, g is the

expected rate of inflation, and k is the expected return on the amount accumulated to fund the retirement.

Equation (2) is described as the strong form of Fisher's theorem because it predicts that a 1 percent increase in the

expected rate of inflation will lead to an increase in the nominal interest rate of more than 1 percent (since 1/(1-T) >1 or 0<T<1).

Assuming a real long-term interest rate of around 3 percent, the long-term

expected rate of inflation would have been about 5 percent in both years.

In our view, underlying inflation is affected primarily by the level of slack in the economy and by the

expected rate of inflation," stated Governor Thiessen (Thiessen 1995d, p.

In the Conference Board survey of households, the

expected rate of inflation over the coming year remained at 4 1/4 percent in the first half of 1995, the same as in each of the four quarters of 1994.

The long-run equilibrium or optimal demand for money (m - p)* depends on the

expected rate of inflation |pi~ and on inflation uncertainty, ||sigma~.

The

expected rate of inflation does not appear explicitly as one of the variables, but its effect is felt through its impact on the risk-free nominal rate of interest, R, as explained below.

But what they're going to do then is they're going to use the nominal wage rate minus the

expected rate of inflation, not minus the actual that turns out to be the case a year later or so.

In turn, this is ensuring that incomes will also record considerable growth rates, which are very likely to be above the

expected rate of inflation and will therefore result in real income increases for private households.

The policy announcement came in the runup to a Commons vote approving plans to increase benefits by only one per cent each year for the next three years, less than the

expected rate of inflation and a cut in real terms.

Moreover, the volatility of the market's

expected rate of inflation, measured by the spread between nominal and inflation-indexed 10-year Treasury bond yields, has trended down since the late 1990s, suggesting an increased confidence in the Fed's resolve to keep inflation low.