and macroeconomic performance. laurence ball, n. gregory mankiw, and david romer, “ the new keynesian economics and the outputinflation trade - off, ” brookings papers on economic activity, no. 1, 1988, pp. 1 – 65. bis central bankers ’ speeches iii. formation of inflation expectations earlier, i mentioned that qqe consists of two elements. one of these was the drastic conversion of the deflationary mindset, and related to this, i would like to consider the formation of inflation expectations in more detail. when considering the formation of inflation expectations, theoretical and empirical research on forward guidance under zero interest rates provides useful insights. with many central banks grappling with the zero lower bound on policy rates not only as a theoretical possibility but as a problem encountered in practice, research on forward guidance has made considerable progress. 2 such research has helped to elucidate that, even in a situation where the zero lower bound has been reached and it is not possible to lower policy rates further, monetary easing effects can be achieved through forward guidance by committing to maintaining zero interest rates, which can be regarded as a mechanism to borrow monetary easing effects from the future ( chart 5 ). the first time this mechanism was employed in the actual conduct of monetary policy was with the introduction of the zero interest rate policy commenced by the bank of japan in february 1999. at that time, the bank committed itself to maintaining a zero interest rate until deflationary concern was dispelled, and the impact of that policy was called the “ policy duration effect. ” backed by growing theoretical research, similar policies were subsequently adopted by central banks of other major advanced economies and have recently come to be referred to as forward guidance. it is well known that in standard macroeconomic models, macroeconomic variables respond strongly to forward guidance by the central bank, giving rise to substantial policy effects. thus, from a theoretical perspective, a commitment to continuing with zero interest rates for a prolonged period not only allows borrowing unlimited monetary easing effects from the future, but such policy effects also materialize immediately. however, these predictions are at odds with the effects actually observed in practice – a phenomenon that has been described as the “ forward guidance puzzle. ” 3 when considering this puzzle, two factors are important. the first is that in standard macroeconomic models, there are no limits to consumption smoothing over time due to the large intertemporal elasticity of substitution and the absence of borrowing constraints.

the second is that inflation expectations respond instantaneously to any change in policy. it is this latter point – the speed with which inflation expectations respond – that i would like to focus on next. in theoretical models assuming a forward - looking phillips curve, inflation expectations respond instantaneously if the commitment regarding future monetary easing is credible. however, inflation expectations observed in practice are highly sticky and change only slowly. this means that in the actual formation of inflation expectations, the backwardlooking component determined by actual inflation rates observed in the past plays a large role. moreover, in standard theoretical models, it is assumed outright that the commitment to monetary easing is perfectly credible, which potentially gives rise to a discrepancy between such theoretical models and reality. if we consider japan ’ s experience, with inflation expectations having declined in the deflationary period, what plays an extremely important role in the process of overcoming deflation is to push inflation expectations back up to close to the target inflation rate and to re - anchor them there. how to do this, including how to deal with the impact of the backwardlooking component of inflation expectations, is a challenge that is not necessarily addressed gauti eggertsson and michael woodford, “ the zero bound on interest rates and optimal monetary policy, ” brookings papers on economic activity, no. 1, 2003, pp. 139 – 211. marco del negro, marc giannoni, and christina patterson, “ the forward guidance puzzle, ” staff reports 574, federal reserve bank of new york, 2012. bis central bankers ’ speeches by theory. moreover, with not only the bank of japan but many other central banks around the world currently having nearly exhausted conventional monetary policy means – that is, lowering short - term interest rates – responding to deflationary pressures and firmly stabilizing inflation expectations at the desired level represents an unprecedentedly difficult challenge. in this sense, the formation of inflation expectations can be regarded as an “ old new ” issue of debate. iv. large - scale purchases of financial assets next, i would like to talk about pushing down the entire yield curve through massive jgb purchases, which is another element of qqe. as is well known, although the market operations of a central bank – by exchanging monetary base for government bonds – are transactions in financial assets that are not perfect substitute, they should be neutral with regard to price formation if arbitrage in financial markets operates fully. 4 however, if arbitrage in