The Hybrid New Keynesian Phillips Curve and Firm-Level Inflation Expectations in Japan

This paper examines inflation dynamics in Japan through estimations of the hybrid New Keynesian Phillips Curve. The estimation with the observed inflation rate in the corporate goods price index and that with the estimated firm-level expected inflation rate are considered. The firm-level expected inflation rate is estimated by the Kanoh (2006)-type extended Carlson-Parkin method. In addition, the validity of the pure forward-looking New Keynesian Phillips Curve and the implication of the flattening of the hybrid New Keynesian Phillips Curve are taken into account as the underlying points of interest. Consequently, our empirical study leads us to the following conclusions. First, the backward-looking factor has a dominant impact on inflation dynamics compared with the future element. Second, the forward-looking element has an unignorable effect on the inflation process, even though it is weaker than the backward-looking factor. Third, our result implies the incompleteness of the pure forward-looking New Keynesian Phillips Curve. It gives us the policy implication that the discussion of monetary policy should include a certain degree of emphasis on the backward-looking perspective in addition to the forward-looking perspective and must examine inflation persistence, although the forward guidance policy by the central banks is a recent important topic. Fourth, the degree of rationality of firm-level inflation expectations is not sufficient: firms’ inflation expectations might not always be as exact as those made by the rational expectations hypothesis. Lastly, the slope of the hybrid New Keynesian Phillips Curve in Japan is very flat in recent years. It implies the Japanese central bank’s current difficulty in conducting monetary policy in that inflation would be less responsive to movements in the measures of aggregate economic activities.