What Drives Euro Area Break-Even Inflation Rates?
40 Pages Posted: 4 Feb 2009
Date Written: January 27, 2009
The yield spread between nominal and inflation-linked bonds (or break-even inflation rates, BEIR) is a fundamental indicator of inflation expectations (and associated premia). This paper investigates which macroeconomic and financial variables explain BEIRs. We evaluate a large number of potential explanatory variables through Bayesian model selection techniques and document their explanatory power at different horizons. At short horizons, actual inflation dynamics is the main determinant of BEIRs. At long horizons, financial variables (i.e. term spread, bond market volatility) become increasingly relevant, but confidence and cyclical indicators remain important.
Keywords: break-even inflation rates, inflation risk premia, business cycle indicators, Bayesian model selection
JEL Classification: C11, C52, E31
Suggested Citation: Suggested Citation