Research on the Formation of Inflation Expectations

About SDGs

Tsutomu Watanabe

Graduate School of Economics

Professor

Japan has experienced deflation - a sustained decline in prices - since the late 1990s, which has acted as an obstacle to economic growth and technological innovation. In order to overcome deflation, the Bank of Japan has conducted a range of monetary easing policies since the spring of 2013. The key to conquering deflation is to overcome people's deflationary mindset and restore sound inflation expectations. Against this background, the aim of this project is to understand how people form inflation expectations and how the central bank can shape this process. Specifically, we implemented a questionnaire survey (conducted annually from 2014 to 2017) of around 15,000 consumers in Japan with regard to their inflation expectations and perception of economic policies and linked this with data on the purchases made by the survey participants in order to examine the effect of various characteristics of individuals (such as the type of store where they shopped, the items they purchased, their income, age, and cohort, etc.) on their inflation expectations. The main finding is that inflation expectations are successively higher for each age cohort, while inflation expectations among younger cohorts continue to be low. Moreover, distinguishing between the cohort effect and the age effect showed that the correlation is largely driven by the cohort effect. Young adults in Japan have grown up without ever experiencing inflation and this experience has greatly shaped their inflation expectations. This result suggests that as young adults grow older and come to play a prominent role in society, the deflationary mindset may become more deeply ingrained in society - a finding that has attracted considerable attention from policymakers and practitioners such as central bankers. We presented the outcome of our project on various occasions such as at the NBER Japan Project Meeting and the Bank of Korea ("The Formation of Consumer Inflation Expectations: New Evidence from Japan’s Deflation Experience").