Skewed policy responses and IT in Latin America

Estimation of forward-looking interest rate rules is ubiquitous in the context of developed economy central banks. This paper considers the five countries in Latin America that have adopted the Inflation Targeting framework and performs estimations of forward-looking rules via i) standard least-squares criteria and ii) quantile regressions. The estimated standard mean effects indicate that Brazil, Chile and Mexico are strongly forward-looking for horizons of a year and more. The estimated quantile effects suggest that policy makers in Brazil, Chile and Mexico are likely to have faced more upside than downside risks to their one-year ahead inflation forecasts when setting their policies

Policy Makers Priors and Inflation Density Forecasts

This paper models an inflation forecast density framework that closely resembles actual policy makers behaviour regarding the determination of the modal point, the uncertainty and asymmetry in the inflation forecasts. The framework combines policy makers prior information about these parameters with a standard parametric density estimation technique using Bayesian theory. The combination crucially hinges on an information-theoretic utility function gains of the policy maker from performing the forecast exercise.Monetary Policy, Inflation Targeting, Bayesian Methods

Real Output Costs of Financial Crises: A Loss Distribution Approach

We study cross-country GDP losses due to financial crises in terms of frequency (number of loss events per period) and severity (loss per occurrence). We perform the Loss Distribution Approach (LDA) to estimate a multi-country aggregate GDP loss probability density function and the percentiles associated to extreme events due to financial crises. We find that output losses arising from financial crises are strongly heterogeneous and that currency crises lead to smaller output losses than debt and banking crises. Extreme global financial crises episodes, occurring with a one percent probability every five years, lead to losses between 2.95% and 4.54% of world GDP.Comment: 31 pages, 10 figure

Monetary Policy under Balance Sheet Uncertainty

A group of developing countries bear high rates of financial dollarisation. Under this circumstance, monetary-policy makers are uncertain about the presence and scale of potentially harmful effects that might appear because of balance sheet mismatches arising from high and unexpected depreciations of the domestic currency. We build a setup whereby central bankers have two competing models in mind. Model A is a standard model for a small open economy whereas Model B has a builtin non-linear balance sheet effect. Whether the balance sheet mismatch problem exists or not, a Bayesian optimization procedure that assigns a positive probability to Model B, perpetuates model-indeterminacy. This happens because the optimal Bayesian regulator does not allow sizeable exchange rate swings (dirty floating), and therefore blurs the information to distinguish among models. We call this effect the Balance Sheet Trap. We show that, given the presence of the Balance Sheet Trap, introducing the learning dynamics into the central banker’s problem is optimal. Thus, we argue that intentional policy experimentation is highly desirable since it provides for an escape to the Balance Sheet Trap

How Does a Global Disinflation Drag Inflation in Small Open Economies?

This paper shows how persistent world inflation shocks hitting a small open economy can re-weight the importance of domestic and foreign factors in the determination of prices. In particular, we study why a global disinflation environment may imply a weakening of the channels whereby domestic shocks affect inflation. We derive a state-dependent Phillips curve based on translog preferences that make the elasticity of substitution of domestic goods sensitive to foreign prices. With this approach we are able to replicate this dragging effect of global disinflation on domestic inflation. We also provide empirical evidence from a wide panel of countries to support the significance of such an effect.Phillips Curve, Translog Aggregator, Competitiveness

How Does Global Disinflation Drag Inflation in Small Open Economies?

This paper shows the way how persistent world inflation shocks hitting a small open economy can re-weight the importance of domestic and foreign factors in the determination of prices. In this sense, we study why the recently observed global disinflation environment may imply a weakening of the standard interest rate channel of monetary policy to affect inflation. We derive a state-dependent Phillips curve based on translog preferences that make the elasticity of substitution of domestic goods sensitive to foreign prices. With this approach we are able to replicate the dragging effect of global disinflation on domestic inflation, as experienced in small open economies such as New Zealand, Chile and Peru.Monetary Policy, Phillips Curve, Translog Preferences, Inflation.

How Does Global Disinflation Drag Inflation in Small Open Economies?

This paper shows the way how persistent world inflation shocks hitting a small open economy can re-weight the importance of domestic and foreign factors in the determination of prices. In this sense, we study why the recently observed global disinflation environment may imply a weakening of the standard interest rate channel of monetary policy to affect inflation. We derive a state-dependent Phillips curve based on translog preferences that make the elasticity of substitution of domestic goods sensitive to foreign prices. With this approach we are able to replicate the dragging effect of global disinflation on domestic inflation, as experienced in small open economies such as New Zealand, Chile and PeruPolicy, Phillips Curve, Translog Preferences.

Evaluation of Wavelet-based Core Inflation Measures: Evidence from Peru

Under inflation targeting and other related monetary policy regimes, the identication of non-transitory inflation and forecasts about future inflation constitute key ingredients for monetary policy decisions. In practice, central banks perform these tasks using so-called "core inflation measures". In this paper we construct alternative core inflation measures using wavelet functions and multiresolution analysis (MRA), and then evaluate their relevance for monetary policy. The construction of wavelet-based core inflation measures (WIMs) is relatively new in the literature and their assessment has not been addressed formally, this paper being the first attempt to perform both tasks for the case of Peru. Another main contribution of this paper is that it proposes two alternative criteria for evaluating core inflation measures: (i) a VAR-based long-run criterion, and (ii) forecast-based criteria. Evidence from Peru shows that WIMs are superior in terms of long-run performance, and that they could improve short-term (up-to-6-months) inflation forecasts.Core inflation, wavelets, forecast, structural VAR

Inflation Targeting and Inflation Behavior: A Successful Story?

This paper estimates the effects of inflation targeting (IT) adoption over inflation dynamics using a wide control group. We contribute to the current IT evaluation literature by considering the adoption of IT by a country as a treatment, just as in the program evaluation literature. Hence, we perform propensity score matching to find suitable counterfactuals to the actual inflation targeters. We find out that IT has helped in reducing the level and volatility of inflation in the countries that adopted it. This result is robust to alternative definitions of treatment and control groups

Inflation Targeting and Inflation Behavior: A Successful Story?

This paper estimates the effects of inflation targeting (IT) adoption over inflation dynamics using a wide control group. We contribute to the current IT evaluation literature by considering the adoption of IT by a country as a treatment, just as in the program evaluation literature. Hence, we perform propensity score matching to determine suitable counterfactuals to the actual inflation targeters. With this approach we find that IT has helped in reducing the level and volatility of inflation in the countries that adopted it. This result is robust to alternative definitions of treatment and control groups. We also find that the e ect of IT in the persistence of inflation is rather weak and not as categorical as the one associated with the mean and volatility of inflation.Inflation Targeting, matching methods