Inflation target and inflation forecasts in Japan

In the literature, a number of studies argued that an explicit inflation targeting regime provides for less uncertainty about future monetary policy actions than a monetary policy regime where there was no explicit numerical inflation target to anchor expectations (see, for example, Yetman, 2017. "The evolution of inflation expectations in Canada and the US," Canadian Journal of Economics vol. 50(3), pp.711-737). But the argument was based on an implicit assumption that the central bank can achieve the explicit inflation target appropriately. Thus it is far from clear whether the argument still holds true when the central bank faces a serious difficulty in achieving its explicit inflation target.

The Bank of Japan (BOJ) is a central bank which adopted in January 2013 an explicit 2% inflation target but faced serious difficulty in achieving the target. The purpose of this paper is to explore whether an explicit inflation targeting regime provides for less uncertainty about future monetary policy actions in Japan. In the analysis, we model inflation forecasts as monotonically diverging from an estimated long-run anchor point towards actual inflation as the forecast horizon shortens. We then estimate panel Phillips curves by using Japanese forecaster-level data of “Ensemble Streamflow Prediction (ESP) forecast” which is collected by Japan Center of Economic Research.

We find significant structural changes in how to form private inflation forecasts. Soon after the BOJ announced the 2% inflation target, the target was the average estimated anchor of private medium-term inflation forecasts. However, the average estimated anchor has declined gradually over time and has been negligible since 2015. The variance of estimates of the long-run anchor, which was considerably low in 2013, has increased substantially since 2015. This indicates that when it turned out that the 2% inflation target would not be feasible in the short-run, Japanese forecasters came to place little weight on the anchor of medium-term inflation forecasts. This implies that an explicit inflation targeting regime provides for less uncertainty about future monetary policy actions only when it is a feasible target.