Problem:
Due to a recession, expected inflation this year is only 3.25%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3.25%. Assume that expectations theory holds and the real risk-free rate is r* = 3%.
Requirement:
Question: If the yield on 3-year Treasury bonds equals the 1-year yield plus 3%, what inflation rate is expected after Year 1?
Note: Please show guided help with steps and answer.