• Role of Expectation in a Liquidity Trap
  Kohei HasuiYoshiyuki NakazonoYuki Teranishi

  Abstract

  This paper investigates how expectation formation affects monetary policy effectiveness in a liquidity trap. We examine two expectation formations: (i) different degrees in anchoring expectation and (ii) different degrees in forward-lookingness to form expectation. We reveal several points as follows. First, under optimal commitment policy, expectation formation for an inflation rate does not markedly change the effects of monetary policy. Second, contrary to optimal commitment policy, the effects of monetary policy significantly change according to different inflation expectation formations under the Taylor rule. The reductions to an inflation rate and the output gap are mitigated if the expectation is well anchored. This rule, however, can not avoid large drops when the degree of forward-lookingness to form expectation decreases. Third, a simple rule with price-level targeting shows some similar outcomes according to different expectation formations as the Taylor rule does. However, in a simple rule with price-level targeting, an inflation rate and the output gap drop less severe due to a history dependent easing and are less sensitive to expectation formations than in the Taylor rule. Even for the Japanese economy, the effects of monetary policy on economic dynamics significantly change according to expectation formations for rules except optimal commitment policy. Furthermore, when the same expectation formations for the output gap are assumed, we observe similar outcomes.

  Introduction

  Expectation is one of the most important factors in the conduct of monetary policy. In particular, managing expectation of an agent is a nontrivial tool in a liquidity trap since the central bank faces limitation in reducing the policy interest rate. A lot of papers, such as Eggertsson and Woodford (2003b), Jung, Teranishi, and Watanabe (2005), Adam and Billi (2006, 2007), and Nakov (2008), analyze optimal monetary policy in a liquidity trap and conclude that optimal commitment policy is very effective. The commitment policy can reduce the real interest rate and stimulate the economy by controlling the inflation expectation. Their conclusions, however, are solely dependent on two important assumptions, i.e., rational expectation and optimal commitment monetary policy.

  2018.02

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• Product Cycles and Prices: Search Foundation
  Mei DongYuki Teranishi

  Abstract

  This paper develops a price model with a search foundation based on product cycles and prices. Observations conclude that firms match with a new product, then set a new price through negotiation and fix the price until the product exits from a market. This evident behavior results in a new model of price stickiness as a Search-based Phillips curve. The model includes a New Keynesian Phillips curve with Calvo’s price adjustment as a special case and describes new phenomena. First, new parameters and variables of a frictional goods market determine price dynamics. As separation rate in a goods market decreases, price becomes more sticky, i.e., a flatter slope in a Search-based Phillips curve, since the product turnover cycle is sluggish. Moreover, other goods market features, such as probability of match, elasticity of match, and bargaining power for a price setting decide price dynamics. Second, goods market friction can make endogenously persistent inflation dynamics without an assumption of indexation to a lagged inflation rate. Third, when the number of a product persistently increases, deflation continues for a long period. It can explain a secular deflation.

  Introduction

  “We have all visited several stores to check prices and/or to find the right item or the right size. Similarly, it can take time and effort for a worker to find a suitable job with suitable pay and for employers to receive and evaluate applications for job openings. Search theory explores the workings of markets once facts such as these are incorporated into the analysis. Adequate analysis of market frictions needs to consider how reactions to frictions change the overall economic environment: not only do frictions change incentives for buyers and sellers, but the responses to the changed incentives also alter the economic environment for all the participants in the market. Because of these feedback effects, seemingly small frictions can have large effects on outcomes.”

  2018.02

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• Why Has Japan Failed to Escape from Deflation?
  Kota WatanabeTsutomu Watanabe

  Abstract

  Japan has failed to escape from deflation despite extraordinary monetary policy easing over the past four years. Monetary easing undoubtedly stimulated aggregate demand, leading to an improvement in the output gap. However, since the Phillips curve was almost flat, prices hardly reacted. Against this background, the key question is why prices were so sticky. To examine this, we employ sectoral price data for Japan and seven other countries including the United States, and use these to compare the shape of the price change distribution. Our main finding is that Japan differs significantly from the other countries in that the mode of the distribution is very close to zero for Japan, while it is near 2 percent for other countries. This suggests that whereas in the United States and other countries the “default” is for firms to raise prices by about 2 percent each year, in Japan the default is that, as a result of prolonged deflation, firms keep prices unchanged.

  Introduction

  From the second half of the 1990s onward, Japan suffered a period of prolonged deflation, in which the consumer price index (CPI) declined as a trend. During this period, both the government and the Bank of Japan (BOJ) tried various policies to escape from deflation. For instance, from 1999 to 2000, the BOJ adopted a “zero interest rate policy” in which it lowered the policy interest rate to zero. This was followed by “quantitative easing” from 2001 until 2006. More recently, in January 2013, the BOJ adopted a “price stability target” with the aim of raising the annual rate of increase in the CPI to 2 percent. In April 2013, it announced that it was aiming to achieve the 2 percent inflation target within two years and, in order to achieve this, introduced Quantitative and Qualitative Easing (QQE), which sought to double the amount of base money within two years. Further, in February 2016, the BOJ introduced a “negative interest rate policy,” in which the BOJ applies a negative interest rate of minus 0.1 percent to current accounts held by private banks at the BOJ, followed, in September 2016, by the introduction of “yield curve control,” in which the BOJ conducts JGB operations so as to keep the 10-year JGB yield at zero percent. See Table 1 for an overview of recent policy decisions made by the BOJ.

  2017.06

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• The Formation of Consumer Inflation Expectations: New Evidence From Japan’s Deflation Experience
  Jess DiamondKota WatanabeTsutomu Watanabe

  Abstract

  Using a new micro-level dataset we investigate the relationship between the inflation experience and inflation expectations of individuals in Japan. We focus on the period after 1995, when Japan began its era of deflation. Our key findings are fourfold. Firstly, we find that inflation expectations tend to increase with age. Secondly, we find that measured inflation rates of items purchased also increase with age. However, we find that age and inflation expectations continue to have a positive correlation even after controlling for the individual-level rate of inflation. Further analysis suggests that the positive correlation between age and inflation expectations is driven to a significant degree by the correlation between cohort and inflation expectations, which we interpret to represent the effect of historical inflation experience on expectations of future inflation rates.

  Introduction

  Since at least the time of Keynes (1936), economic agents’ expectations of future inflation rates have played a pivotal role in macroeconomics. Woodford (2003) describes the central importance of inflation expectations to modern macroeconomic models due to the intertemporal nature of economic problems, while Sargent (1982) and Blinder (2000) highlight the dependence of monetary policy on these expectations. However, despite the important role of inflation expectations, their formal inclusion in macroeconomic models is usually ad-hoc with little empirical justification.

  2017.05

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