Decomposing Euro Area Sovereign Debt Yields into Inflation Expectations and Expected Real Interest Rates

  • Rajmund MIRDALA Faculty of Economics, Technical University of Kosice, Slovakia

Abstract

Quantitative easing conducted by European central bank to fight persisting risks of deflation is drawing an attention of increasing number of empirical studies. Moreover, effectiveness of monetary policy at near zero inflation rates reveals lot of issues on whether interest rates really have a lower bound around zero percent. As a result, traditional views on the role of inflation expectations and expected real interest rates in the long-term interest rates determination face the challenge of fundamental revision. In the paper we analyze relative contributions of inflation expectations and expected real interest rates to long-term interest rates on government bonds leading path as well as their responses to both types of shocks in the Euro Area member countries using SVAR methodology. We also decompose long-term interest rates into transitory and permanent components. Our research revealed considerable differences in the role of inflation expectations and expected real interest rates shocks in determining long-term interest rates between core and periphery countries of the Euro Area. The crisis period even intensified this trend.

References

[1] Acharya, V.V., Steffen, S. 2015. The ‘Greatest’ Carry Trade Ever? Understanding Eurozone Bank Risks, Journal of Financial Economics, 115(2): 215-236
[2] Archick, K. 2015. The European Union: Current Challenges and Future Prospects in Brief, [Congressional Research Service Report] Washington, Congressional Research Service, 13 p.
[3] Arouba, S.B. 2014. Term Structures of Inflation Expectations and Real Interest Rates: The Effects of Unconventional Monetary Policy, [Federal Reserve Bank of Minneapolis, Staff Report No.502/2014], Minneapolis, Federal Reserve Bank of Minneapolis, 51 p.
[4] Bindseil, U., Winkler, A. 2012. Dual Liquidity Crises under Alternative Monetary Frameworks: A Financial Accounts Perspective, [ECB Working Paper, no. 1478], Frankfurt am Main, European Central Bank, 61 p.
[5] Blanchard, O.J., Quah, D. 1988. The Dynamic Effects of Aggregate Demand and Aggregate Supply Disturbances, [National Bureau of Economic Research Working Paper No. 4637] New York, National Bureau of Economic Research, 39 p.
[6] Booth, G.G., Ciner, C. 2000. The Relationship between Nominal Interest Rates and Inflation: International Evidence, Journal of Multinational Financial Management, 11(3): 269-280
[7] Borio, C., Disyatat, P. 2009. Unconventional Monetary Policies: An Appraisal, [BIS Working Paper, no. 292], Basel, Bank for International Settlements, 29 p.
[8] Campbell, J.Y., Shiller, R.J. 1991. Yield Spreads and Interest Rate Movements: A Bird’s Eye View, Review of Economic Studies, 58(3): 495-514
[9] Chernov, M., Mueller, P. 2012. The Term Structure of Inflation Expectations, Journal of Financial Economics, 106(2): 367-394
[10] Christensen, J.H.E., Lopez, J.A., Rudebusch, G.D. 2008. Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields, [Federal Reserve Bank of San Francisco, Working Paper No.34/2008], San Francisco, Federal Reserve Bank of San Francisco, 39 p.
[11] Christensen, J.H.E., Lopez, J.A., Rudebusch, G.D. 2012. Extracting Deflation Probability Forecasts from Treasury Yields, International Journal of Central Banking, 8(4): 21-60
[12] Cochrane, J.H., Piazzesi, M. 2005. Bond Risk Premia, American Economic Review, 95(1): 138-160
[13] Crowder, W.J., Hoffman, D.L. 1996. The Long-Run Relationship between Nominal Interest Rates and Inflation: The Fisher Equation Revisited, Journal of Money, Credit and Banking, 28(1): 102-118
[14] De Grauwe, P. 2013. Design Failures in the Eurozone: Can they be fixed?, [LSE ‘Europe in Question’ Discussion Paper, no. 57], London, London School of Economics, 61 p.
[15] Deacon, M., Derry, A. 1994. Estimating Market Interest Rate and Inflation Expectations from the Prices of UK Government Bonds, Bank of England Quarterly Bulletin, 34: 232-240
[16] Den Haan, W.J. 1995. The Term Structure of Interest Rates in Real and Monetary Economics, Journal of Economic Dynamics and Control, 19(5-7): 909-940
[17] Eijffinger, S., Schaling, E., Verhagen, W. 2000. The Term Structure of Interest Rates and Inflation Forecast Targeting, [CEPR, Discussion Paper 2375], London, Centre for Economic Policy Research, 23 p.
[18] Emiris, M. 2006. The Term Structure of Interest Rates in a DSGE Model, [National Bank of Belgium, Working Paper Research No. 88] Brussels, National Bank of Belgium, 55 p.
[19] Engsted, T. 1995. Does the Long-Term Interest Rate Predict Future Inflation? A Multi-Country Analysis, The Review of Economics and Statistics, 77(1): 42-54
[20] European Central Bank. 2015. Real Convergence in the Euro Area: Evidence, Theory and Policy Implications, ECB Economic Bulletin, 5: 30-35
[21] Evans, M.D.D. 1998. Real Rates, Expected Inflation, and Inflation Risk Premia, Journal of Finance, 53(1): 187-218
[22] Fendel, R. 2009. Note on Taylor Rules and the Term Structure, Applied Economics Letters, 16(11): 1097-1101
[23] Garcia, R., Perron, P. 1996. An Analysis of the Real Interest Rate under Regime Shifts, Review of Economics and Statistics, 78(1): 111-125
[24] Gerlach-Kristen, P., Rudolf, B. 2010. Macroeconomic and Interest Rate Volatility under Alternative Monetary Operating Procedures, [Swiss National Bank, Working Paper No. 2010-12] Zurich, Swiss National Bank, 40 p.
[25] Gürkaynak, R.S., Sack, B., Wright, J.H. 2007. The U.S. Treasury Yield Curve: 1961 to the Present. Journal of Monetary Economics, 54(8): 2291-2304
[26] Haubrich, J.G., Pennacchi, G., Ritchken, P. 2012. Inflation Expectations, Real Rates, and Risk Premia: Evidence from Inflation Swaps, Review of Financial Studies, 25(5): 1588-1629
[27] Kim, D.H., Orphanides, A. 2012. Term Structure Estimation with Survey Data on Interest Rate Forecasts, Journal of Financial and Quantitative Analysis, 47(1): 241-271
[28] Krishnamurthy, A., Vissing-Jorgensen, A. 2011. The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy, [National Bureau of Economic Research Working Paper No. 17555] New York, National Bureau of Economic Research, 53 p.
[29] Kulish, M. 2007. Should Monetary Policy Use Long-term Rates? B.E. Journal of Macroeconomics, 7(1): 1-26
[30] Labadie, P. 1994. The Term Structure of Interest Rates over the Business Cycle. Journal of Economic Dynamics and Control, 18(3-4): 671-697
[31] Lai, K.S. 2004. On Structural Shifts and Stationarity of the Ex Ante Real Interest Rate, International Review of Economics and Finance, 13(2): 217-228
[32] Lanne, M. 2001. Near Unit Root and the Relationship between Inflation and Interest rates: A Reexamination of the Fisher Effect, Empirical Economics, 26(2): 357-366
[33] Mcgough, B., Rudebusch, G., Williams, J.C. 2005. Using a Long-term Interest Rates as the Monetary Policy Instrument, Journal of Monetary Economics 52(5): 855-879
[34] Michaud, F.-L., Upper, CH. 2008. What Drives Interbank Rates? Evidence from the Libor Panel, [BIS Quarterly Review, March 2008], Basel, Bank for International Settlements, p. 47-58
[35] Neely, Ch.J., Rapach, D.E. 2008. Real Interest Rates Persistence: Evidence and Implications, [Federal Reserve Bank of St. Louis, Review No. 6/2008] St. Louis, Federal Reserve Bank of St. Louis, 90(6): 609-641
[36] Novotný, V. (ed.) 2013. From Reform to Growth: Managing the Economic Crisis in Europe. Brussels, Centre for Economic Studies, 543 p.
[37] Peersman, G. 2011. Macroeconomic Effects of Unconventional Monetary Policy in the Euro Area, [ECB Working Paper, no. 1397], Frankfurt am Main, European Central Bank, 33 p.
[38] Ragan, C. 1995. Deriving Agents’ Inflation Forecasts from the Term Structure of Interest Rates. [Bank of Canada, Working Paper, No. 1/1995] Ottawa, Bank of Canada, 41 p.
[39] Rudebusch, G.D. 2002. Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia, Journal of Monetary Economics, 49(6): 1161-1187
[40] Rudebusch, G.D., Sack, B.P., Swanson, E.T. 2006. Macroeconomic Implications of Changes in the Term Premium, [Federal Reserve Bank of San Francisco, Working Paper No.46/2006], San Francisco, Federal Reserve Bank of San Francisco, 48 p.
[41] Rudebusch, G., Swanson, E. 2012. The Bond Premium in a DSGE Model with Long-run Real and Nominal Risks, American Economic Journal: Macroeconomics, 4(1): 105-143
[42] St-Amant, P. 1996. Decomposing U.S. Nominal Interest Rates into Expected Inflation and Ex Ante Real Interest Rates Using Structural VAR Methodology, [Bank of Canada, Working Paper No. 2/1996] Ottawa, Bank of Canada, 28 p.
[43] Taylor, H. 1982. Interest Rates: How Much Does Expected Inflation Matter, Business Review, 65(4): 3-12
[44] Tobias, A., Wu, H 2010. The Term Structures of Inflation Expectations, [Federal Reserve Bank of New York, Staff Report No.362/2010], New York, Federal Reserve Bank of New York, 32 p.
[45] Vayanos D., Vila, J.L. 2009. A Preferred-Habitat Model of the Term Structure of Interest Rates, [National Bureau of Economic Research Working Paper No. 15487] New York, National Bureau of Economic Research, 57 p.
[46] Von Ondarza N. 2013. Strengthening the Core or Splitting Europe, [SWP Research Paper No. 2] Berlin, Stiftung Wissenschaft und Politik, 34 p.
[47] Wood, J.H. 1983. Do Yield Curves Normally Slope Up? The Term Structure of Interest Rates, 1862-1982, Economic Perspectives, 7(4): 17-23
[48] Wright, J. 2011. Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Data Set, American Economic Review, 101(4): 1514-1534
Published
2017-04-04
How to Cite
MIRDALA, Rajmund. Decomposing Euro Area Sovereign Debt Yields into Inflation Expectations and Expected Real Interest Rates. Journal of Advanced Research in Law and Economics, [S.l.], v. 6, n. 4, p. 714-737, apr. 2017. ISSN 2068-696X. Available at: <https://journals.aserspublishing.eu/jarle/article/view/943>. Date accessed: 17 apr. 2024.