The Cabinet Office on Thursday effectively called on the Bank of Japan to introduce an inflation target if it terminates its quantitative monetary easing policy.
An "alternative framework" should be provided to "stabilize market expectations" when the policy is terminated, the office said in its report "Japanese Economy 2005-2006."
Such a framework would be needed to prevent excessive volatility in the markets and ensure the reversal of deflation, according to the report.
The alternative framework can be interpreted as an inflation target, analysts said.
"It is very important for monetary policy management to allow expectations of stable, moderate inflation to be formed" to overcome deflation, the report says.
The report was also taken as discouraging the central bank from terminating quantitative easing, an ultra-easy monetary policy the BOJ introduced in March 2001 to fight deflation.
It warned that "long-term interest rates may rise substantially on growing monetary policy uncertainties" as the core consumer price index ends a prolonged streak of year-on-year declines.
A stable year-on-year reading at or above zero in the core CPI is one of the conditions the BOJ has set for termination of the quantitative easing policy.
The core CPI is expected to stop dropping sometime in the near future.