4Non-technical summary 5

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4Non-technical summary 5

We show that microfounded DSGE models with nominal rigidities can be successful in replicating features of bond yield data, including sizeable term premia and volatile long-term yields, which have previously been considered puzzling in general equilibrium frameworks. At the same time, sample moments of consumption growth and inflation can be fit relatively well. The improved model performance does not arise directly from the presence of nominal rigidities. However, this feature introduces (short-run) monetary non-neutrality, so that monetary policy affects consumption dynamics and bond prices. A high degree of Ôinterest rate smoothingÕ in the policy rule is essential for our results.* We thank Isabel Correia, Monika Piazzesi, Mehmet Pasaogullari, Federico Ravenna, Frank Schorfeide, Simeon Tsonev and seminar participants at the ESWC 2005 for useful comments and suggestions. A previous

This paper estimates the size and dynamics of inflation risk premia in the euro area, based on a joint model of macroeconomic and term structure dynamics. Information from both nominal and index‐linked yields is used in the empirical analysis. Our results indicate that the inflation risk premium on euro area 10‐year nominal yields was approximately equal to 20 basis points on average over the 1999–2007 period. The inflation premium has also been subject to moderate, but statistically significant fluctuations. For the post‐2003 period in which reliable index‐linked bond prices are available, our results suggest that increases in the raw break‐even inflation rate above 2%, the upper bound of the European Central Bank's definition for price stability, have mostly reflected variations in the inflation risk premium, while long‐term inflation expectations have remained well anchored.