RIEB Discussion Paper Series No.2024-11

Title

Measuring Trend Inflation Using Financial Condition: The Case of Japan

Abstract

This paper proposes a market-based indicator of trend inflation by exploiting a cointegrating relationship between inflation and financial conditions. We model inflation jointly with long-term interest rates, the money stock, and the nominal exchange rate, and estimate the cointegrating relationship using dynamic ordinary least squares (DOLS). The implied common-trend can be expressed as a simple weighted average of observable financial series, making the indicator transparent, easy to replicate, and straightforward to update in real time via recursive estimation. Using monthly data from 1983 to 2022, we show that the indicator contains statistically significant information about future inflation and improves forecasts of two-year-ahead average inflation relative to widely used core measures. The forecasting gains reflect two mechanisms: the common-trend extraction filters out tran sitory movements in observed inflation and provides a cleaner real-time estimate of the contemporaneous trend toward which headline inflation tends to revert. Overall, the results suggest that financial-market information provides a useful complement to traditional core indicators for monitoring persistent inflationary pressures and for policy analysis of medium to long-run inflation dynamics in Japan.

Keywords

Inflation; Stochastic trend; Cointegration; Financial market; Forecasting

JEL Classification

C32, E31

Inquiries

Masahiko SHIBAMOTO
Research Institute for Economics and Business Administration (RIEB)
Center for Computational Social Science (CCSS)
Kobe University
Rokkodai-cho, Nada-ku, Kobe
657-8501 Japan
Phone: +81-78-803-7036
FAX: +81-78-803-7059