Expected Inflation and Inflation Risk Premium in the Euro Area and in the United States

Abstract

This paper uses the celebrated no-arbitrage affine Gaussian term structure model applied to index-linked and standard government bonds to derive expected inflation rates and inflation risk premia, in the euro area and in the US. Maximum likelihood estimates show that the model describes the evolution of the nominal and real term structures by using three latent factors which can be interpreted as two real factors and one inflation factor. These provide important information on expected inflation and inflation risk premia. The results highlight some striking differences between the euro area and the US. In the US, forward inflation risk premia become sizable around the start of the late-2000s financial crisis and considerably increase just before the adoption of the first unconventional monetary policy measures in March 2009. By contrast, in the euro area forward inflation risk premia remain unchanged even after the adoption of the unconventional monetary policy measures following the most acute phases of the financial crisis, in October 2008 and in May 2010. However, long-term inflation expectations have been well anchored over the past years.

Keywords: real and nominal term structure, inflation risk premium, affine term structure, Kalman filter

JEL Classification: C02, G10, G12