Macroeconomic Impact of Shifts in Long-term Inflation Expectations

This paper examines the impact of shifts in long-term inflation expectations on economic activity and price dynamics in Japan using a time-varying parameter vector autoregressive (TVP-VAR) model. Our empirical findings demonstrate that exogenous positive shocks to long-term inflation expectations improve the output gap and generate upward pressure on inflation rates. These results suggest the existence of an "expectations channel" in Japan, whereby higher inflation expectations stimulate private sector spending through mechanisms such as reducing real funding costs. Looking at the analysis by period, it indicates that during the deflationary phase of the 2000s, declining long-term inflation expectations likely contributed to persistent downward pressure on prices, potentially serving as one factor that hindered Japan's exit from sustained deflation. However, following the introduction of the "price stability target" and Quantitative and Qualitative Monetary Easing (QQE) in 2013, this contribution reversed, appearing to exert upward pressure on inflation rates. In this respect, the findings suggest that the "management of expectations" intended by monetary policy during this period demonstrated some effectiveness. Nevertheless, as inflation rates subsequently declined, the upward contribution of inflation expectations to the inflation rate diminished, failing to anchor expectations to the price stability target. This outcome suggests the inherent difficulty in maintaining a sustained influence on long-term inflation expectations.