Decomposing Sovereign Debt Yields in the New Euro Area Member Countries into Inflation Expectations and Expected Real Interest Rates

Recent deflationary pressures and ultra-low interest rate environment in the Euro Area revealed fundamentally specific implications for the evaluation of monetary policy effectiveness. Redefinition of traditional views on price stability and the role of inflation expectations under near zero level inflation environment draws attention of increasing number of empirical studies. Changing contribution of inflation expectations and expected real interest rates to the long-term interest rates determination (Kim and Orphanides, 2012) are one of the most important implications of the recent deflationary periods in the Euro Area. In the paper we employ SVAR methodology to identify inflation expectations and expected real interest rates shocks and calculate variance decomposition and impulse-response functions of long-term nominal interest rates in the new Euro Area member countries. Our research revealed considerable differences in the role of inflation expectations and expected real interest rates shocks in determining long-term interest rates among individual new Euro Area member countries. The crisis period even intensified this trend.