A simple model for inflation targeting in Brazil

Paulo Springer de Freitas · Marcelo Kfoury Muinhos

52 citations0/0 files storedEconomia Aplicada

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

Based on a 6 equation model by Haldane and Battini (1999), we estimated a Phillips and an IS equations for Brazil after the Real Plan, in order to study the transmission mechanism of the monetary policy. The results show that interest rate affects output gap with a lag of one quarter and output is positively related to inflation with a one lag only. The devaluation of the nominal exchange rate has also a contemporaneous effect on inflation. We also made stochastic simulations in order to depict the inflation and output gap volatility loci under alternative Taylor-type rules and under an optimal rule, which minimizes a loss function that depends on a weighted average of inflation and output gap variances. The stochastic simulation showed that when compare to the variance in inflation, output gap variance appears to be more sensitive to the weights given in the loss function. It also showed that optimization procedures longer than 6 periods are inefficient and the most efficient frontier horizons are set within the range of 2 to 4 periods. Finally, sub-optimal but simple rules, like Taylor type rules can perform as well as the optimal ones, depending on the parameters chosen and on the preferences ofthe Central Bank.

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References

2000Open-Economy Inflation Targeting 1997Inflation Targeting: A New Framework for Monetary Policy?1999Inflation targeting as a monetary policy rule 1997Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets 1998Robustness of Simple Monetary Policy Rules under Model Uncertainty 1997The Scope for Inflation Targeting in Developing Countries 2002Information Technology and Productivity: Where Are We Now and Where Are We Going?2004Monetary policy rules for financially vulnerable economies

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