Consumer’s perceived and expected inflation in Japan—irrationality or asymmetric loss?

This study examines asymmetry in loss functions of consumer’s perceived and expected consumer price index inflation in Japan. We find strong upward bias of perceived and one-year-ahead inflation expectations, and evidence against rationality under symmetric loss functions. We find considerable evidence of asymmetric loss in perceived and expected inflation and support for rationality upon assuming asymmetric loss functions. Strong biases in consumers’ perceived and expected inflation result from asymmetric loss rather than irrationality. Using epidemiology models, we find that expected inflation is strongly related to perceived inflation with no significant role for actual inflation. Moreover, consumers gradually incorporate central bank forecasts, but not professional forecasts, into their inflation expectations. This indicates that asymmetric loss in perceived inflation is important in forming inflation expectation. The central bank should take into consideration the asymmetric loss in consumers’ inflation expectations and the close relationship between the inflation expectations and perceived inflation in formulating monetary policy.