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Market-based Long-term Inflation Expectations in Japan: A Refinement on Breakeven Inflation Rates


September 30, 2020
Kazuhiro Hiraki*1
Wataru Hirata*2


In Japan, the breakeven inflation rate (BEI), commonly used as a proxy for market-based long-term inflation expectations, has evolved lower than survey-based measures of long-term inflation expectations. The literature has pointed to three factors, other than long-term inflation expectations, that act as drivers of long-term BEI rates: (i) the deflation protection option premium of inflation-linked bonds, (ii) the liquidity premium of the bonds, and (iii) the spread between nominal and real term premia (the term premium spread). This paper estimates an affine term structure model to decompose Japan's BEI into long-term inflation expectations and these three other driving factors. Our empirical results show that the deflation protection option premium for Japan's Inflation-Indexed Bonds (JGBi) has pushed the BEI up, while the liquidity premium of JGBi and the term premium spread have pulled it down, all having non-negligible contributions to developments in the BEI. This indicates that the evolution of Japan's BEI has been driven by these three factors as well as by the long-term inflation expectations of market participants. Consequently, the estimated long-term inflation expectations have evolved higher than the BEI throughout almost the entire estimation period.

JEL Classification
E31, E43, G12

Breakeven inflation rate, Inflation expectations, Liquidity premium, Deflation protection option premium, Term premium

The authors are grateful to the staff at the Bank of Japan, especially Hibiki Ichiue, Tomiyuki Kitamura, Takushi Kurozumi, Satoshi Kobayashi, Tomohide Mineyama, Teppei Nagano, Kenji Nishizaki, Ryohei Oishi, Masaki Tanaka, and Yoichi Ueno for helpful comments and discussions. All remaining errors are our own. The views expressed in this paper are those of the authors and do not necessarily reflect the official views of the Bank of Japan.

  1. *1Monetary Affairs Department, Bank of Japan
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  2. *2Monetary Affairs Department, Bank of Japan
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