Posts filed under “Inflation”
Japanese Inflation Expectations, Revisited
Benjamin R. Mandel and Geoffrey Barnes
Liberty Street Economics April 22, 2013
An important measure of success for monetary policy is a central bank’s ability to anchor inflation expectations; inflation expectations influence actual inflation and, hence, the achievement of a given inflation goal. This notion has special significance for Japan, where CPI inflation has been intermittently negative since 1994 and where it is widely believed that expectationsof future inflation have been persistently negative (that is, ongoing deflation is expected). In this post, we describe and evaluate an alternative, market-based measure of Japanese inflation expectations based on international price parity conditions. We find that recent inflation expectations have attained a level substantially higher than their previous peaks over the past three years.
By way of background, recent policy action by the Bank of Japan has shone a spotlight on Japanese inflation expectations. On April 4, the Bank announced a program called Quantitative and Qualitative Monetary Easing (QQE), which was a pledge to drastically ramp up asset purchases to increase the monetary base, and to extend the duration of assets held on the Bank’s balance sheet. Since nominal yields on Japanese government bonds have been quite low for some time, a preferred indicator of QQE’s success would be a decline in real interest rates as inflation expectations move closer to the Bank’s recently announced 2 percent price stability target.
How does one go about measuring Japanese inflation expectations? The consensus on this topic is that there is no single reliable measure. A commonly used market-based gauge of U.S. inflation expectations is the difference in yield between nominal and Treasury inflation-protected securities (TIPS)—the breakeven inflation rate. Analogous measures come from over-the-counter derivatives called inflation swaps. In Japan, the market for inflation-protected government bonds, called JGBi’s, is very thinly traded and a majority of the issuance has been bought back by the Ministry of Finance in recent years. These factors have cast doubt on the ability of JGBi prices to convey reliable information about inflation expectations. Swaps suffer from similar liquidity issues.
Alternative extant measures of inflation expectations are available from surveys of households, investors, and professional forecasters. However, survey responses may by formed in a backward-looking manner, making them more responsive to actual inflation than predictive of the future. The range of views offered by market‑ and survey-based measures is illustrated in the chart below. While measures of five- and ten-year expectations have converged somewhere around 1 percent in recent months, in the past analysts would have little confidence of even getting the correct sign of expected inflation by looking at any given measure.
Forecasting Inflation? Target the Middle
Brent Meyer, Guhan Venkatu, and Saeed Zaman
The Median CPI is well-known as an accurate predictor of future inflation. But it’s just one of many possible trimmed-mean inflation measures. Recent research compares these types of measures to see which tracks future inflation best. Not only does the Median CPI outperform other trims in predicting CPI inflation, it also does a better job of predicting PCE inflation, the FOMC’s preferred measure, than the core PCE.
At the end of 2012, the Federal Open Market Committee (FOMC) adopted a new guideline for determining when it would consider raising interest rates. What is different about the guideline is that it gives specific thresholds for various economic indicators, which if reached, would signal a change in the Committee’s interest-rate target. These thresholds were spelled out in the meeting statement: “…the Committee…currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6 1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
While the unemployment-rate threshold is expressed in terms of current conditions, the inflation threshold is in terms of the outlook for inflation. By specifying the inflation threshold in terms of its forecasted values, the FOMC will still be able to “look through” transitory price changes, like they did, for example, when energy prices spiked in 2008. At that time, the year-over-year growth rate in the Consumer Price Index (CPI) jumped up above 5.0 percent but subsequently plummeted below zero a year later when the bottom fell out on energy prices. At the time, the Committee maintained the federal funds rate target at 2.0 percent, choosing not to react to the energy price spike. Under the explicit inflation threshold, the Committee will not lose its ability to remain forward looking, and will rely on forecasts of inflation.
To help inform those inflation projections, Chairman Bernanke, in a recent press conference, stated that the Committee “will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation.” In this Economic Commentary, we highlight the usefulness of trimmed-mean measures (chiefly, the median CPI) in gauging the underlying inflation trend and forecasting future inflation.
Drilling Down to the “Core”
Perhaps the most well-known underlying inflation measure is the “core” Consumer Price Index (CPI).1 This measure excludes the prices of food and energy items because those were the two most volatile categories when the core CPI was conceived. While energy remains the most volatile broad category, food prices have become much less volatile in recent years.
Labor Slack Points to Structural Employment Problem click for larger chart Source: Bloomberg > Nice chart today from Bloomberg Briefs suggesting that we have structural problems in the labor market post-credit crisis. The income gap based on education levels is well established; there is also a low-wage bias in the economy – we seem…Read More
Source: WSJ I wanted to take a moment out this morning to briefly discuss the differences between real, nominal, after tax, and total returns: Why is it that nearly any chart that gets posted — be it index, stock, bond or commodity — invariably results in a knee jerk demand for an inflation…Read More
DJIA – Dow Jones Industrial Average (index) pre- and post- Gold Click for full chart Source: Peter Williams, Advisor Perspectives Interesting look at long term Dow but using the Gold Standard as a dividing line. To be blunt, I am really not sure what to make of it. Was going off of the Gold Standard inevitable, and therefore unimportant? Or was…Read More
I cringe each time I hear some inflationista — you may have met that guy who insisted there was no inflation during the 2000s as the dollar plunged 41% but now sees inflation everywhere — brings today up the Weimar Republic every chance he gets. Here is a look at long term Inflation we spoke…Read More
Happy anniversary Helicopter Ben! It was 10 years ago today that Mr. Bernanke gave his speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here” as at the time some “expressed concern that we may soon face a new problem, the danger of deflation or falling prices” as reported inflation rates were low at the time…Read More
Bloomberg Brief points to this report from Carl J. Riccadonna, senior U.S. Economist at Deutsche Bank, looking at the misery index — Inflation + Unemployment. Riccadonna took the usual analysis one step further, applying it to the swing states in the Presidential contest. What did he find: “The following states are “worse-off” based on…Read More