Estimating Inflation Expectations with a Limited Number of Inflation-indexed Bonds

We estimate inflation expectations and inflation risk premia using inflation forecasts from Consensus Economics and Australian inflation-indexed bond price data. Inflation-indexed bond prices are assumed to be non-linear functions of latent factors, which we model via an affine term structure model. We solve the model using a non-linear Kalman filter. While our results should not be interpreted too precisely due to data limitations and model complexity, they nonetheless suggest that long-term inflation expectations are well anchored within the 2 to 3 per cent inflation target range, while short-run inflation expectations are more volatile and more closely follow contemporaneous inflation. Further, while long-term inflation expectations are generally stable, inflation risk premia are much more volatile. This highlights the potential benefits of our measures over break-even measures of inflation which include both components.