The Evolution of Inflation Expectations in Euro Area Markets

44 Pages Posted: 1 Dec 2016

See all articles by Ricardo Gimeno

Ricardo Gimeno

Banco de España

Eva Ortega

Bank of Spain, DG Economics, Statistics and Research

Date Written: November 30, 2016

Abstract

This paper explores the behaviour of inflation expectations across countries that share their monetary policy, in particular those of the European Monetary Union. We investigate the possible common features at the various horizons, as well as differentials across euro area countries. A multi-country dynamic factor model based on Diebold et al. (2008), where we also add a liquidity risk component, is proposed and estimated using daily data from inflation swaps for Spain, Italy, France, Germany and the euro area as a whole, and for a wide range of horizons. It allows us to calculate the proportion of common vs country-specific components in the term structure of inflation expectations. We find sizable differences in inflation expectations across the main euro area countries only at short maturities, while in general a common component predominates throughout the years, especially at long horizons. The common long-run level of inflation expectations is estimated to have fallen since late 2014, while an increased persistence of lower expected inflation and for longer horizons is estimated from 2012. There has been no reversal in either of these characteristics following the announcement and implementation of the ECB’s unconventional monetary policy measures.

Keywords: Inflation Expectations; Monetary Union; Inflation-Linked Swaps; Multicountry Dynamic Factor Model; Liquidity Risk Premium

JEL Classification: E31; C32; G13

Suggested Citation

Gimeno, Ricardo and Ortega, Eva, The Evolution of Inflation Expectations in Euro Area Markets (November 30, 2016). Banco de Espana Working Paper No. 1627, Available at SSRN: https://ssrn.com/abstract=2877655 or http://dx.doi.org/10.2139/ssrn.2877655

Ricardo Gimeno (Contact Author)

Banco de España ( email )

Madrid 28014
Spain

Eva Ortega

Bank of Spain, DG Economics, Statistics and Research ( email )

Alcala 50
Madrid, 28014
Spain

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