Disinflation Costs Under Inflation Targeting in Small Open Economy Economy

Since 1991, inflation in Colombia was reduced from 25% on average to about 6% more recently. Although this performance is in line with a long run inflation target of 3%, some analysts ask whether the Central Bank should continue disinflating. In this paper we present a dynamic stochastic general equilibrium model of inflation targeting for a small open economy to answer this question. We calibrate the model to the Colombian economy and compute the welfare cots and benefits of achieving the long run inflation target. We find that the long run welfare gains are about 4.54% in terms of capital. Furthermore, accounting for the transition the welfare gains are about 1.18% in terms of capital. Our results differ from previous findings because transition costs are introduced and our environment considers the presence of real rigidities (monopolistic competition) and nominal rigidities (sticky information) in a small open economy. We also analyze the sensitivity of the results to some key parameters and conclude that higher price flexibility leads to lower gains from reducing inflation and that a country with markups. The weight given to the inflation gap in the monetary policy rule is important, as a more aggressive Central Bank can improve welfare. Finally, we find that disinflation is more expensive in the case of a closed economy.Small Open Economy,Inflation Targeting,Compensation;Colombia.

Disinflation costs under inflation targeting in small open economy

Since 1991, inflation in Colombia was reduced from 25% on average to about 6% more recently. Although this performance is in line with a long run inflation target of 3%, some analysts ask whether the Central Bank should continue disinflating. In this p

Disinflation costs under inflation targeting in a small open economy

Since 1991, inflation in Colombia was reduced from 25% on average to about 6% more recently. Although this performance is in line with a long run inflation target of some analysts ask whether the Central Bank should continue disinflating. In this paper we present a dynamic stochastic general equilibrium model of inflation targeting for a small open economy to answer this question. We calibrate the model to the Colombian economy and compute the welfare costs and benefits of achieving the long run inflation target. We find that the long run welfare gains are about 4.54% in terms of capital. Furthermore, accounting for the transition the welfare gains are about 1.18% in terms of capital. Our results differ from previous findings because transition costs are introduced and our environment considers the presence of real rigidities (monopolistic competition) and nominal rigidities (sticky information) in a small open economy. We also analyze the sensitivity of the results to some key parameters and conclude that higher price flexibility leads to Iower gains from reducing inflation and that a country with markups around 15% receives higher gains than those countries with different levels of markups. The weight given to the inflation gap in the monetary policy rule is important, and finally the transition is more expensive in the case of a closed economy.Magíster en EconomíaMaestrí

Sobre los efectos macroeconómicos de la composición de la deuda pública en Colombia

Este artículo presenta un análisis cuantitativo del impacto macroeconómico de la forma como se financia el déficit fiscal en una economía pequeña y abierta. En particular, nos enfocamos en evaluar el impacto macroeconómico de una situación en la que, dado un nivel de déficit fiscal, el gobierno decide entre financiarlo con deuda doméstica o externa. Para este propósito empleamos un modelo de equilibrio general dinámico y estocástico para una economía pequeña y abierta. Al calibrar el modelo a la economía colombiana, encontramos que los efectos de una sustitución de deuda pública externa por interna dependen de qué tan permanente sea dicha sustitución. Una sustitución transitoria tiene efectos macroeconómicos despreciables, con excepción de su impacto sobre los flujos de capital privados (“efecto portafolio”). Es decir, un aumento de la deuda pública doméstica vis a vis una reducción en la externa, es balanceado por una reducción de los activos externos netos privados. Por el contrario, una sustitución permanente de un 10 % de deuda externa por doméstica tiene efectos macroeconómicos transitorios pero considerables sobre la actividad real y los flujos de capital. Dicha recomposición genera un aumento en los activos externos netos de un 5 % acompañada de una depreciación nominal cercana al 1 %. Aunque nuestros resultados son generales en ambientes con flexibilidad de precios, especulamos que pueden variar en presencia de incertidumbre acerca de la sostenibilidad de las finanzas públicas y/o rigideces nominales y reales

On the macroeconomic effects of public debt substitution

En este artículo se presenta un análisis cuantitativo del impacto macroeconómico de la forma como se financia el déficit fiscal en una economía pequeña y abierta. En particular, nos enfocamos en evaluar el impacto macroeconómico de una situación en la que, dado un nivel de déficit fiscal, el gobierno decide entre financiarlo con deuda doméstica o externa. Para este propósito empleamos un modelo de equilibrio general dinámico y estocástico para una economía pequeña y abierta. Al calibrar el modelo a la economía colombiana, encontramos que los efectos de una sustitución de deuda pública externa por interna dependen de si ésta es transitoria o permanente. Una sustitución transitoria tiene efectos reales despreciables, con excepción de su impacto sobre los flujos de capital privados (efecto portafolio"). Es decir, un aumento de la deuda pública doméstica vis à vis una reducción en la externa, es balanceado por una reducción de los activos externos netos privados. Por el contrario, una sustitución permanente de un 10% de deuda externa por doméstica tiene efectos macroeconómicos transitorios pero considerables sobre la actividad real: una reducción inicial en la inversión, producto de mayores tasas de interés que resultaría en un aumento en los activos externos netos de un 5% con una depreciación nominal cercana al 1%. Esta sustitución permite reducir transitoriamente la tasa de impuesto a la renta en un 2%, el cual aumentaría persistentemente el consumo hasta en un 3%."This paper presents a quantitative analysis of the way in which a government finances its fiscal deficit in a small open economy. In particular, it focuses on the evaluation of the macroeconomic impact of a situation in which, given a fiscal deficit, the government decides whether to finance it with domestic or external debt. For this purpose a small open economy DSGE model is used. The model is calibrated to the colombian economy. The results depend on whether the substitution is transitory or permanent. The former has negligible macroeconomic effects, except for the impact on private capital flows (we call this a «portfolio effect»). An increase in the domestic public debt equally matched by a reduction in the external debt, is balanced by a reduction in private net foreign assets. On the contrary, a permanent substitution of 10% in the level of external public debt by domestic debt, has transitory but significant effects on the level of real economic activity and capital flows. Such a recomposition generates a 5% increase in net foreign assets (a capital outflow) along with a 1% nominal nominal depreciation. Although our results are quite general under flexible prices, we especulate that they may change in the presence of uncertainty about the sustainability of fiscal deficit and/or nominal and real rigidities

Inflation targeting in a small open economy: the colombian case

This paper presents a dynamic stochastic general equilibrium model of inflation targeting in small open economy. We calibrate the model to the Colombian economy and present the response of some macroeconomic variables to different types of shocks that