Achieving the Bank of Japan’s Inflation Target

IMF Working Papers, November 1, 2019

Source details

Objective: Assess the likelihood of the Bank of Japan (BoJ) achieving its price stability target of 2 percent inflation.
Context: The BoJ introduced various unconventional monetary policy tools since the launch of Abenomics in 2013.
Tool developed: A forward-looking open-economy general equilibrium model with endogenously determined policy credibility and an effective lower bound, intended for forecasting and policy analysis (FPAS) for Japan.

Model type: Forward-looking open-economy general equilibrium model.
Key model features:
- Endogenously determined policy credibility.
- Effective lower bound (interest rate floor) incorporated.
- Designed for FPAS (forecasting and policy analysis) for Japan.
Target variable: Headline CPI inflation and inflation expectations.

Baseline scenario:
- Likelihood of reaching the BoJ’s 2 percent inflation target over the medium term is below 40 percent.
- This baseline assumes the absence of other policy reactions aside from monetary policy.
Alternative risk scenarios:
- The likelihood of achieving the 2 percent inflation target is even lower under alternative risk scenarios (no numeric likelihoods provided in the source beyond "even lower").
Credibility shock:
- A positive shock to central bank credibility increases the likelihood of reaching the 2 percent inflation target.
- With higher credibility, less accommodative macroeconomic policies would be required to achieve the target.

Monetary policy alone, under the assumptions of the baseline, has a sub-40 percent chance of attaining the 2 percent inflation target over the medium term.
Enhancing central bank credibility is an effective channel to raise the probability of achieving the inflation target and can reduce the need for highly accommodative macroeconomic policies.
Policymakers should consider interactions between credibility, unconventional tools, and the effective lower bound when designing strategies to reach the 2 percent target.

Source: "Achieving the Bank of Japan’s Inflation Target", IMF Working Papers 2019, No. 229.