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The inflation risk premium in the post-Lehman period

Author

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  • Camba-Méndez, Gonzalo
  • Werner, Thomas

Abstract

In this paper we construct model-free and model-based indicators for the inflation risk premium in the US and the euro area. We study the impact of market liquidity, surprises from inflation data releases, inflation volatility and deflation fears on the inflation risk premium. For our analysis, we construct a special dataset with a broad range of indicators. The dataset is carefully constructed to ensure that at every point in time the series are aligned with the information set available to traders. Furthermore, we adopt a Bayesian variable selection procedure to deal with the strong multicollinearity in the variables that potentially can explain the movements in the inflation risk premium. We find that the inflation risk premium turned negative, on both sides of the Atlantic, during the post-Lehman period. This confirms the recent finding by Campbell et al. (2016) that nominal bonds are no longer "inflation bet" but have turned into "deflation hedges". We also find, and contrary to common beliefs, that indicators of inflation uncertainty alone cannot explain the movements in the inflation risk premium in the post-Lehman period. The decline in the inflation risk premium seems mostly related to increased deflation fears and the belief that inflation will stay far away from the monetary policy target rather than declining inflation uncertainty. This in turn would suggest that central banks should not be complacent with low or even negative inflation risk premia. JEL Classification: E44, G17

Suggested Citation

  • Camba-Méndez, Gonzalo & Werner, Thomas, 2017. "The inflation risk premium in the post-Lehman period," Working Paper Series 2033, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20172033
    Note: 336092
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    References listed on IDEAS

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    Cited by:

    1. Marcello Pericoli, 2019. "An assessment of recent trends in market-based expected iflation in the euro area," Questioni di Economia e Finanza (Occasional Papers) 542, Bank of Italy, Economic Research and International Relations Area.
    2. van Wijnbergen, Sweder & Olijslagers, Stan & de Vette, Nander, 2020. "Debt sustainability when r - g," CEPR Discussion Papers 15478, C.E.P.R. Discussion Papers.
    3. M. Deroose & A. Stevens, 2017. "Low inflation in the euro area : Causes and consequences," Economic Review, National Bank of Belgium, issue i, pages 111-125, June.
    4. Alberto Di Iorio & Marco Fanari, 2020. "Break-even inflation rates: the Italian case," Questioni di Economia e Finanza (Occasional Papers) 578, Bank of Italy, Economic Research and International Relations Area.
    5. Robert Amano & Thomas Carter & Sylvain Leduc, 2019. "Precautionary Pricing: The Disinflationary Effects of ELB Risk," Working Paper Series 2019-26, Federal Reserve Bank of San Francisco.
    6. Koester, Gerrit & Lis, Eliza & Nickel, Christiane & Osbat, Chiara & Smets, Frank, 2021. "Understanding low inflation in the euro area from 2013 to 2019: cyclical and structural drivers," Occasional Paper Series 280, European Central Bank.
    7. Hartmann, Philipp & Smets, Frank, 2018. "The first twenty years of the European Central Bank: monetary policy," Working Paper Series 2219, European Central Bank.
    8. Rostagno, Massimo & Altavilla, Carlo & Carboni, Giacomo & Lemke, Wolfgang & Motto, Roberto & Saint Guilhem, Arthur & Yiangou, Jonathan, 2019. "A tale of two decades: the ECB’s monetary policy at 20," Working Paper Series 2346, European Central Bank.
    9. Sara Cecchetti & Davide Fantino & Alessandro Notarpietro & Marianna Riggi & Alex Tagliabracci & Andrea Tiseno & Roberta Zizza, 2021. "Inflation expectations in the euro area: indicators, analyses and models used at Banca d’Italia," Questioni di Economia e Finanza (Occasional Papers) 612, Bank of Italy, Economic Research and International Relations Area.
    10. Juan Angel Garcia & Aubrey Poon, 2018. "Trend Inflation and Inflation Compensation," IMF Working Papers 2018/154, International Monetary Fund.
    11. Egwakhe A. J & Falana R. B & Asikhia O. O & Magaji N, 2020. "Business Strategies and Competitive Advantage: Evidence from Flour Mill Companies in Lagos State, Nigeria," Journal of Economics and Behavioral Studies, AMH International, vol. 12(2), pages 17-26.
    12. Jose E. Gomez-Gonzalez & Jorge M. Uribe & Oscar M. Valencia, 2023. "Sovereign Risk and Economic Complexity: Machine Learning Insights on Causality and Prediction," IREA Working Papers 202315, University of Barcelona, Research Institute of Applied Economics, revised Nov 2023.
    13. Schupp, Fabian, 2020. "The (ir)relevance of the nominal lower bound for real yield curve analysis," Working Paper Series 2476, European Central Bank.
    14. B. De Backer & M. Deroose & Ch. Van Nieuwenhuyze, 2019. "Is a recession imminent? The signal of the yield curve," Economic Review, National Bank of Belgium, issue i, pages 69-93, June.
    15. Gregory de Walque & Thomas Lejeune & Ansgar Rannenberg, 2023. "Empirical DSGE model evaluation with interest rate expectations measures and preferences over safe assets," Working Paper Research 433, National Bank of Belgium.
    16. Gomez-Gonzalez, Jose E. & Uribe, Jorge M. & Valencia, Oscar, 2024. "Sovereign Risk and Economic Complexity," IDB Publications (Working Papers) 13393, Inter-American Development Bank.
    17. Busetto, Filippo, 2024. "Asymmetric expectations of monetary policy," Bank of England working papers 1058, Bank of England.
    18. Sweder van Wijnbergen & Stan Olijslagers & Nander de Vette, 2020. "Debt sustainability when r - g smaller than 0: no free lunch after all," Tinbergen Institute Discussion Papers 20-079/VI, Tinbergen Institute.
    19. Burban, Valentin & De Backer, Bruno & Schupp, Fabian & Vladu, Andreea Liliana, 2022. "Decomposing market-based measures of inflation compensation into inflation expectations and risk premia," Economic Bulletin Boxes, European Central Bank, vol. 8.

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    More about this item

    Keywords

    inflation expectations; Inflation linked swaps; inflation risk premium;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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