Publication - The effects of a central bank's inflation forecasts on private sector forecasts: Recent evidence from Japan - by Masazumi Hattori, Steven Kong, Frank Packer and Toshitaka Sekine
Copyright: Centralbahnplatz 2
4051 Basel
Switzerland
BISBCHBB Website:www.bis.org
1. Introduction
How central banks should best communicate to the market is an increasingly important topic in the central banking literature. With ever greater frequency, central banks communicate to the market through forecasts of prices and output over both the near and medium-term.
These forecasts can serve the purpose of reducing errors and uncertainty by private forecasters, both with regard to economic fundamentals as well as the future policy actions of the central bank. In so doing, they can improve the effectiveness of other central bank communications and policies as well as economic welfare more generally. This paper aims to contribute to the literature on central bank forecasts, by documenting how much the release of the forecasts of one major central bank – the Bank of Japan (BOJ) – has been influencing private sector expectations of inflation. At the same time, central banks of the 21st century generally rely on a publically stated medium-term inflation target to help anchor expectations of inflation. Inflation targeting (IT) removes uncertainty about at least one of the ultimate objectives of the central bank, however much macroeconomic and global shocks may influence nearterm inflation outcomes.
The Bank of Japan adopted inflation targeting in early 2013, relatively late in the community of central banks in advanced economies, and more than a decade after they began to release economic forecasts. This paper also aims to examine whether the impact of Bank of Japan forecasts on those of the private sector has been influenced by the adoption of an inflation target. In contrast to most other advanced economies’ experiences with inflation targeting, where IT was introduced in an effort to bring overly high inflation down and stabilise it at low levels, the Bank of Japan moved to IT when existing inflation (and indeed the inflation of the previous 15 years) was below the new target. In crosscountry work, Ehrmann (2015) suggests that central bank may have more difficulty in hitting newly adopted inflation targets from below than from above, as inflation expectations in such cases can be sticky in response to positive inflation surprises.
The data set of Ehrmann’s paper ends too quickly to lend insight into Japan’s experience however. While there is a large literature on the effectiveness of inflation forecasts, as well as one on the effectiveness of IT targeting frameworks for monetary policy, our paper is the first, to our knowledge, that directly examines how the influence of inflation forecasts by the central bank might be impacted by the introduction of an inflation targeting regime, especially in the environment of lower inflation rates than the newly introduced target rate. At the same time, Japan’s below target inflation can no longer be viewed as unusual, as inflation levels in advanced as well as many emerging economies are persistently weak and below established goals.
For countries that may be considering introducing an inflation targeting regime in the midst of a wave of disinflationary pressure, the experience of Japan may be worth examination. To preview our results, the estimations that follow, consistent with earlier findings, suggest that Bank of Japan forecasts significantly influence private sector forecasts. Upon the introduction of the inflation targeting regime, preliminary estimates of the influence of the Bank of Japan forecasts were lowered.
However, in the case of next year forecasts that serve as a better proxy for medium to long-term inflation expectations, a primary concern for the central bank, the estimate of diminished influence are not statistically significant when the confounding impact of the Lehman failure in 2008 is accounted for. At the same time, the differences in measures of the forecast accuracy of BOJ and private sectors are not statistically significant, which is consistent with central bank forecasts playing more of a complementary role than a dominant role in shaping inflationary expectations.
To preview our results, the estimations that follow, consistent with earlier findings, suggest that Bank of Japan forecasts significantly influence private sector forecasts. Upon the introduction of the inflation targeting regime, preliminary estimates of the influence of the Bank of Japan forecasts were lowered. However, in the case of next year forecasts that serve as a better proxy for medium to long-term inflation expectations, a primary concern for the central bank, the estimate of diminished influence are not statistically significant when the confounding impact of the Lehman failure in 2008 is accounted for.
At the same time, the differences in measures of the forecast accuracy of BOJ and private sectors are not statistically significant, which is consistent with central bank forecasts playing more of a complementary role than a dominant role in shaping inflationary expectations. The rest of the paper will proceed as follows. In the next section, we review the literature on central bank communication, with a particular focus on central bank forecasts, as well as the introduction of inflation targeting regimes. In section 3, we discuss the data and institutional background, as well as outline the empirical strategy behind the tests for the effectiveness of central bank forecasts. Sections 4 to 7 present the main results, tests of forecast accuracy, event study evidence and an array of robustness checks; Section 8 concludes.
Copyright: Centralbahnplatz 2
4051 Basel
Switzerland
BISBCHBB Website:www.bis.org
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