Determinants of households' inflation expectations

In this paper, we investigate the determinants of households' inflation expectations in Japan and the United States. We estimate a vector autoregression model in which the four endogenous variables are inflation expectations, inflation, the short-term nominal interest rate and the output gap, with energy prices and (fresh) food prices being exogenous. Short-term nonrecursive restrictions are imposed taking account of simultaneous codependence between realized inflation and expected inflation. We find, first, that responding not only to changes in energy prices and food prices but also to monetary policy shocks, inflation expectations adjust more quickly than does realized inflation. This explains why Japanese and US data indicate that inflation expectations lead realized inflation. Second, the effects of changes in energy prices and food prices on inflation and inflation expectations are large in the short run in Japan, while in the United States, they are not only large but also long lasting. Third, shocks to expectations occasionally fluctuate greatly, and can have self-fulfilling effects on realized inflation. The self-fulfilling property is more apparent in the United States than in Japan.