Problem 6-10 Inflation

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* = 2.75%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 2.75%, what inflation rate is expected after Year 1? Round your answer to two decimal places.

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