The Formation of Inflation Expectations: Micro-data Evidence from Japan

Using a unique survey of 50,000 households for 4 years, this study examines how households form inflation expectations. There are three findings. First, disagreements on inflation forecasts among households are larger for the shorter-term than those for the longer-term horizon; additionally, disagreements are predicted by how frequently households collect information about overall inflation rates. Inflation forecasts for the 1-year horizon are widely dispersed, while those for the 10-year horizon are anchored below 2%. Second, households heterogeneously update their information sets on prices. 46% of the households collect information about the consumer price index at least once a quarter, while the remaining households less frequently or never obtain this information. Third, forecast revisions are sensitive to a change in food prices. We show that more than half of households are attentive only to a change in food prices and may form their inflation expectations using food price changes as a signal of fluctuations in the overall inflation rates. The existence of numerous households that are inattentive to the nationwide inflation rates casts doubt on the transmission mechanism of the monetary policy through the management of expectations.