[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/ice/wpaper/wp97.html
   My bibliography  Save this paper

Extracting inflation expectations and risk premia from the breakeven inflation rate in Iceland

Author

Listed:
  • Thorarinn Petursson
Abstract
The yield spread between a conventional nominal bond and a corresponding inflation-indexed bond – the so-called breakeven inflation rate – is a common measure of investors’ inflation expectations. But the spread also includes two risk premia that can distort the breakeven rate as a measure of inflation expectations. I use a signal-extraction approach is used to jointly estimate underlying inflation expectations and the inflation and liquidity risk premia from Icelandic data on 2-year breakeven inflation rates. The estimated 2-year inflation expectations are much smoother than the breakeven rate and remain above the official 2.5% inflation target for most of the sample period. The two risk premia are found to be large and time-varying, highlighting the need for caution when interpreting the breakeven rate as a direct measure of inflation expectations. Finally, I find that the three subcomponents of the breakeven rate react differently to an unanticipated monetary tightening. The tightening leads to a gradual and persistent decline in inflation expectations and the inflation risk premium partly offset by a temporary increase in the liquidity premium, consistent with the “risk-taking” channel of monetary policy.

Suggested Citation

  • Thorarinn Petursson, 2024. "Extracting inflation expectations and risk premia from the breakeven inflation rate in Iceland," Economics wp97, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp97
    as

    Download full text from publisher

    File URL: https://www.sedlabanki.is/library/Skraarsafn---EN/Working-Papers/WP97_Extracting%20inflation%20expectations%20and%20risk%20premia%20from%20%20the%20breakeven%20inflation%20rate%20in%20Iceland.pdf
    Download Restriction: no
    ---><---

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • 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
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ice:wpaper:wp97. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Central Bank of Iceland (email available below). General contact details of provider: https://edirc.repec.org/data/sedgvis.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.