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

Author Info

Listed author(s):
  • 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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File URL: http://www.rba.gov.au/publications/rdp/2011/pdf/rdp2011-01.pdf
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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
Handle: RePEc:rba:rbardp:rdp2011-01
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Keywords: inflation expectations; inflation risk premia; affine term structure model; break-even inflation; non-linear Kalman filter;

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Find related papers by JEL classification:
  • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
  • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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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. Camba-Méndez, Gonzalo & Werner, Thomas, 2017. "The inflation risk premium in the post-Lehman period," Working Paper Series 2033, European Central Bank.
  2. 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.
  3. Will Devlin & Deepika Patwardhan, 2012. "Measuring market inflation expectations," Economic Roundup, The Treasury, Australian Government, issue 2, pages 5-17, August.
  4. Tahlee Stone, 2016. "The Sensitivity of Personal Income to GDP Growth," RBA Bulletin, Reserve Bank of Australia, pages 1-9, December.
  5. Tosapol Apaitan, 2015. "Extracting Market Inflation Expectations: A Semi-structural Macro-finance Term Structure Model," PIER Discussion Papers 4., Puey Ungphakorn Institute for Economic Research, revised Sep 2015.
  6. Angus Moore, 2016. "Measures of Inflation Expectations in Australia," RBA Bulletin, Reserve Bank of Australia, pages 23-31, December.

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