Japan's Inflation Dynamics and Agents' Behavior

On November 26, 2015, the Research and Statistics Department of the Bank of Japan (BOJ) and the Center for Advanced Research in Finance (CARF) of the University of Tokyo held a joint conference titled "Japan's Inflation Dynamics and Agents' Behavior." This document is a staff translation of the conference minutes. All contributions submitted to the conference are available from the Bank of Japan website as working papers or research papers (some are available only in Japanese). The main takeaways of the conference can be summarized in the following four points. First, there was a broad consensus among conference participants that inflation dynamics in Japan have recently changed along with a gradual shift in inflation expectations. As a result, Japan seems to have started escaping from a deflationary equilibrium. However, there remains considerable dispersion in inflation expectations and aggregate inflation expectations have not yet reached 2 percent, the inflation rate that the Bank of Japan aims to attain under its Quantitative and Qualitative Monetary Easing policy. How to best model expectations formation remains an important challenge for academia as well as policy makers. Second, conference participants highlighted the importance of the "norm" as a key determinant of firms' price-setting behavior. The norm can be regarded as a variant of inflation expectations, but carries the connotation of fairness and shared values in society. During the deflation era, zero inflation was the strong social norm in Japan and hence an overwhelming majority of firms did not change their prices. Although not yet conclusive, there have recently been indications of a change in the norm and firms' price-setting behavior. Third, many conference participants pointed out that firms have remained very cautious in terms of raising wages and increasing investment, even if their price-setting may have become a little more aggressive. A possible reason is that they are not sufficiently confident regarding future prospects of the domestic economy and their competitiveness at the global level. Another possible reason is that Japan's labor market for regular workers has remained very rigid due to existing practices such as lifetime employment. At the same time, the bargaining power of trade unions has diminished substantially and there has been an increase in temporary workers, who are paid lower wages. There was a strong sense among participants that, under these circumstances, the government needs to steadily implement its growth strategy in order to raise growth expectations. Monetary easing plays a complementary role to that growth strategy. Fourth, it was pointed out that, along with the change in inflation dynamics, Japanese households' behavior seems to have changed in that they are taking more risks in terms of their portfolio choices.