Supplementary Paper Series for the "Assessment" (3): Inflation-Overshooting Commitment:An Analysis Using a Macroeconomic Model

Takuji Kawamoto, Jouchi Nakajima and Tomoaki Mikami
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Takuji Kawamoto: Bank of Japan
Tomoaki Mikami: Bank of Japan

No 21-E-9, Bank of Japan Working Paper Series from Bank of Japan

Abstract: In its "Inflation-Overshooting Commitment," the Bank of Japan commits to continuing to expand the monetary base until the year-on-year rate of increase in the CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. Through the commitment, the Bank of Japan is implementing a so-called "makeup strategy," which aims to offset a part of past inflation misses from the target by allowing actual inflation to overshoot the target for some time and thereby stabilizing average inflation over the business cycle. Existing studies have shown that such makeup strategies are actually effective for the U.S. economy. This paper examines the effectiveness of the makeup strategy for Japan's economy, where inflation expectations formation is known to be largely adaptive. Specifically, we build a small-scale macroeconomic model for Japan's economy and conduct simulation analysis to study the implications of adopting the makeup strategy for early achievement of the inflation target as well as the incurring social welfare costs. Simulation results show that when the inflation rate has been below the target, it is effective to stabilize average inflation by offsetting the past inflation misses over some makeup windows. In addition, the results suggest that when the natural rate of interest is lower, the optimal makeup window becomes longer.

Keywords: Monetary Policy; Inflation-overshooting commitment; Makeup strategy; Average inflation targeting; Stochastic simulation (search for similar items in EconPapers)
JEL-codes: C53 E31 E47 E52 E58 (search for similar items in EconPapers)
Date: 2021-07-13
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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