Title: Market-based long-term inflation expectations in Japan: A refinement on breakeven inflation rates
Authors: Kazuhiro Hiraki - Bank of Japan (Japan) [presenting]
Wataru Hirata - Bank of Japan (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). An affine term structure model is estimated to decompose Japan's BEI into long-term inflation expectations and these three other driving factors. The empirical results show that the deflation protection option premium for Japan's Inflation-Indexed Bonds (JGBi) has pushed the BEI up. In contrast, 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's 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.