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

We develop a novel technique to estimate inflation expectations and inflation risk premia when only a limited number of inflation-indexed bonds are available. The method involves pricing coupon-bearing inflation-indexed bonds directly in terms of an affine term structure model, and avoids the usual requirement of estimating zero-coupon real yield curves. We estimate the model using a non-linear Kalman filter and apply it to Australia. The results suggest that long-term inflation expectations in Australia are well anchored within the Reserve Bank of Australia’s inflation target range of 2 to 3 percent, and that inflation expectations are less volatile than inflation risk premia.