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This paper analyses the nominal and real interest rate term structures in the United Kingdom over the fifteen-year period that the UK monetary authorities have pursued an explicit inflation target, using a four-factor essentially affine term structure model. The model imposes no-arbitrage restrictions across nominal and real yields, enabling to decompose nominal forward rates into expected real short rates, expected inflation, real term premia and inflation risk premia. The authors find that inflation risk premia and longer-term inflation expectations fell significantly when the Bank of England was made operationally independent in 1997.
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