Moreover, in the years of high inflation, there was a particularly close link between the prevailing rate of inflation and expected inflation.

i n(e) = Estimated Inflation Growth Rate in a hypothetic “n period”.

Thus, the expected inflation rate has a unidirectional causal relationship with the nominal interest rate, that is, a higher expected inflation rate will result in a rising nominal interest rate.

In particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected inflation than in the pre-Volcker period.

He identifies inflation expectations and ex ante real interest rate shocks by assuming that nominal interest rates and inflation expectations move one-for-one in the long-run—they are cointegrated (1,1)—and that the real interest rate is stationary.

Expected inflation, for its part, depends mainly on the market's expectations about monetary policy in Canada.