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Market-based Long-term Inflation Expectations in Japan: A Refinement on Breakeven Inflation Rates

Kazuhiro Hiraki and Wataru Hirata
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Kazuhiro Hiraki: Bank of Japan

No 20-E-5, Bank of Japan Working Paper Series from Bank of Japan

Abstract: In Japan, the breakeven inflation rate (BEI), commonly used as a proxy for market-based long-term inflation expectations, has evolved lower than survey-based measures of long-term inflation expectations. The literature has pointed to three factors, other than long-term inflation expectations, that act as drivers of long-term BEI rates: (i) the deflation protection option premium of inflation-linked bonds, (ii) the liquidity premium of the bonds, and (iii) the spread between nominal and real term premia (the term premium spread). This paper estimates an affine term structure model to decompose Japan fs BEI into long-term inflation expectations and these three other driving factors. Our empirical results show that the deflation protection option premium for Japan fs Inflation-Indexed Bonds (JGBi) has pushed the BEI up, while the liquidity premium of JGBi and the term premium spread have pulled it down, all having non-negligible contributions to developments in the BEI. This indicates that the evolution of Japan fs BEI has been driven by these three factors as well as by the long-term inflation expectations of market participants. Consequently, the estimated long-term inflation expectations have evolved higher than the BEI throughout almost the entire estimation period.

Keywords: Breakeven inflation rate; Inflation expectations; Liquidity premium; Deflation protection option premium; Term premium (search for similar items in EconPapers)
JEL-codes: E31 E43 G12 (search for similar items in EconPapers)
Date: 2020-09-30
New Economics Papers: this item is included in nep-mac, nep-mon and nep-ore
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