Inflation target and anchor of inflation forecasts in Japan

In literature, a number of studies argued that an explicit inflation targeting regime provides less uncertainty about future inflation rates through anchoring expectations. However, it is far from clear whether the argument still holds true when the central bank faces a serious difficulty in achieving the target. The Bank of Japan (BOJ) is a central bank that has adopted an explicit inflation target but faced a serious difficulty in achieving it. The purpose of this paper is to explore whether the explicit inflation targeting regime could anchor inflation expectations in Japan. In the analysis, we estimate panel Phillips curves by using Japanese forecaster-level data of “ESP Forecast”. We find significant structural changes in how to form inflation expectations. Before the BOJ announced the 2% inflation target, the estimated anchor of inflation expectations was negative. The new target increased the estimated anchor to significant positive values. This suggests that the BOJ's explicit inflation target could partly anchor inflation expectations. However, the estimated anchor has never reached the target. More importantly it started to decline when it turned out that the 2% target would not be feasible in the short-run. This implies that an explicit inflation targeting needs to be a feasible one to anchor inflation expectations persistently.