What Drives Euro Area Break-Even Inflation Rates?

40 Pages Posted: 4 Feb 2009

See all articles by Matteo Ciccarelli

Matteo Ciccarelli

European Central Bank (ECB)

Juan A. Garcia

European Central Bank (ECB)

Date Written: January 27, 2009

Abstract

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

Ciccarelli, Matteo and Garcia, Juan Angel, What Drives Euro Area Break-Even Inflation Rates? (January 27, 2009). ECB Working Paper No. 996, Available at SSRN: https://ssrn.com/abstract=1316216

Matteo Ciccarelli (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Juan Angel Garcia

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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