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

Author

Listed:
  • Kazuhiro Hiraki

    (Bank of Japan)

  • Wataru Hirata

    (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.

Suggested Citation

  • Kazuhiro Hiraki & Wataru Hirata, 2020. "Market-based Long-term Inflation Expectations in Japan: A Refinement on Breakeven Inflation Rates," Bank of Japan Working Paper Series 20-E-5, Bank of Japan.
    • Handle: RePEc:boj:bojwps:wp20e05
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    More about this item

    Keywords

    Breakeven inflation rate; Inflation expectations; Liquidity premium; Deflation protection option premium; Term premium;
    All these keywords.

    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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