The Impact of Regime Change on the Influence of the Central Bank's Inflation Forecasts: Evidence from Japan's Shift to Inflation Targeting

Many central banks release inflation forecasts to reduce uncertainty; at the same time, an increasing number rely on a publicly stated medium-term inflation target to help anchor expectations. We examine how the adoption of an inflation target (IT) by a major central bank, the Bank of Japan (BOJ), influenced the impact of its inflation forecasts on private-sector expectations. We find that the relative accuracy of central bank forecasts versus those of the private sector declined, a deterioration not evident in GDP forecasts. This appears to have been due to a structural (upward) shift in central bank inflation forecasts with the introduction of the IT regime. Regression results suggest that private-sector forecasts discounted the shift in central bank forecasts. The results are consistent with a regime, after the adoption of inflation targeting, in which the private sector viewed the central bank forecasts as upwardly biased. More generally, they confirm the difficulty in raising inflation expectations from below in the presence of an effective lower bound in the nominal policy interest rate.