When conducting a wavelet analysis to explore the connection between expected inflation and

interest rates, several theoretical insights and patterns may emerge. Here are some theoretical
aspects that wavelet analysis can reveal:

1. Time-Varying Frequency Components: Theoretical insight: Economic variables, such

as expected inflation and interest rates, often exhibit time-varying behavior. Traditional
time-series analysis might miss important frequency components that change over time.
Wavelet analysis reveals: The presence of specific frequency components at different
points in time. It can show how the dominant frequencies associated with the relationship
between expected inflation and interest rates evolve over different economic periods.
2. Localized Changes and Structural Breaks: Theoretical insight: Economic conditions,
policy changes, or external shocks can lead to structural breaks in the relationship
between expected inflation and interest rates. Wavelet analysis reveals: Localized
changes in the time-frequency domain, highlighting periods of structural shifts or
alterations in the relationship. This can provide insights into the impact of economic
events or policy decisions on the connection between these variables.
3. Frequency Synchronization and Phase Relationships: Theoretical insight: The
relationship between expected inflation and interest rates may exhibit frequency-
dependent synchronization or phase relationships. Wavelet analysis reveals: Coherence
and phase information at different frequencies. It can show whether certain components
of expected inflation and interest rates move together or exhibit lagged responses,
providing a deeper understanding of the temporal dynamics.
4. Identification of Short-Term and Long-Term Dynamics: Theoretical insight:
Economic variables often have both short-term fluctuations and long-term trends.
Wavelet analysis reveals: Multiscale components, allowing for the identification of short-
term and long-term patterns in the connection between expected inflation and interest
rates. This can help distinguish between transitory and persistent dynamics.
5. Nonlinearities in the Relationship: Theoretical insight: Linear models may not fully
capture the complexities of the relationship between expected inflation and interest rates.
Wavelet analysis reveals: Nonlinear patterns in the time-frequency domain. It can
highlight areas where the relationship deviates from linearity, providing a more accurate
representation of the underlying dynamics.
6. Lead-Lag Relationships: Theoretical insight: Changes in expected inflation may lead or
lag changes in interest rates, and vice versa. Wavelet analysis reveals: The lead-lag
structure across different frequencies, offering insights into the direction of causality
between expected inflation and interest rates over time.
7. Cyclical and Trend Components: Theoretical insight: Economic variables often exhibit
cyclical components and long-term trends. Wavelet analysis reveals: The presence of
cyclical and trend components in the time-frequency domain. This can help identify
business cycle effects and long-term trends that contribute to the overall relationship.

By applying wavelet analysis to the connection between expected inflation and interest rates,
researchers can gain a nuanced understanding of the temporal dynamics, frequency components,
and structural characteristics that may be overlooked by traditional time-series methods. This
enhanced understanding can inform economic modeling, policy decisions, and investment
strategies.