Bank of Japan working paper finds market-perceived inflation response in policy rule is near zero at the effective lower bound and varies across participants

The Bank of Japan published a working paper estimating how Japan’s market participants perceive the central bank’s monetary policy reaction function using survey-based market data. The paper finds that the perceived policy response to inflation is almost zero when the nominal interest rate is constrained by the effective lower bound, but tends to rise during subsequent interest rate hike periods, consistent with participants updating their beliefs in response to observed policy changes. While the perceived inflation coefficient generally increases outside the effective lower bound, it remains low even during recent rate hikes among respondents whose long-term inflation expectations deviate downward from the price stability target, suggesting expectations of a prolonged low-rate environment within this subgroup. The paper also finds that participants who assume a stronger policy response to inflation tend to have long-term inflation expectations that are more stable around 2%, indicating that perceptions are state-dependent and may be associated with time variation in macroeconomic stability and monetary policy effectiveness. The paper is circulated in the Bank of Japan Working Paper Series to stimulate discussion and comment, and the views expressed are those of the authors rather than the Bank.