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Estimating Inflation Expectations with a Limited Number of Inflation-indexed Bonds

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  • Richard Finlay

    (Reserve Bank of Australia)

  • Sebastian Wende

    (Reserve Bank of Australia)

Abstract

We estimate inflation expectations and inflation risk premia using inflation forecasts from Consensus Economics and Australian inflation-indexed bond price data. Inflation-indexed bond prices are assumed to be non-linear functions of latent factors, which we model via an affine term structure model. We solve the model using a non-linear Kalman filter. While our results should not be interpreted too precisely due to data limitations and model complexity, they nonetheless suggest that long-term inflation expectations are well anchored within the 2 to 3 per cent inflation target range, while short-run inflation expectations are more volatile and more closely follow contemporaneous inflation. Further, while long-term inflation expectations are generally stable, inflation risk premia are much more volatile. This highlights the potential benefits of our measures over break-even measures of inflation which include both components.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2011-01.

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Date of creation: Mar 2011
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Handle: RePEc:rba:rbardp:rdp2011-01

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Related research

Keywords: inflation expectations; inflation risk premia; affine term structure model; break-even inflation; non-linear Kalman filter;

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  1. Joyce, Michael A.S. & Lildholdt, Peter & Sorensen, Steffen, 2010. "Extracting inflation expectations and inflation risk premia from the term structure: A joint model of the UK nominal and real yield curves," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 281-294, February.
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Cited by:
  1. David Norman & Anthony Richards, 2012. "The Forecasting Performance of Single Equation Models of Inflation," The Economic Record, The Economic Society of Australia, vol. 88(280), pages 64-78, 03.
  2. Will Devlin & Deepika Patwardhan, 2012. "Measuring market inflation expectations," Economic Roundup, Treasury, Australian Government, issue 2, pages 5-17, August.

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