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How do adaptive learning expectations rationalize stronger monetary policy response in Brazil?

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  • Dizioli, Allan
  • Wang, Hou

Abstract

This paper estimates a standard Dynamic Stochastic General Equilibrium (DSGE) model that includes a wage and price Phillips curves with different expectation formation processes for Brazil and the USA. Other than the standard rational expectation process, we also use a limited rationality process, the adaptative learning model. In this context, we show that the separate inclusion of a labor market in the model helps to anchor inflation even in a situation of adaptive expectations, a positive output gap and inflation above target. The estimation results show that the adaptive learning model does a better job in fitting the data in Brazil. In addition, the estimation shows that expectations are more backward-looking and started to drift away sooner in 2021 in Brazil than in the USA. We then conduct optimal policy exercises that prescribe front-loading monetary policy tightening and easing earlier than the estimated monetary policy rule in the context of positive output gaps and inflation far above the central bank target.

Suggested Citation

  • Dizioli, Allan & Wang, Hou, 2024. "How do adaptive learning expectations rationalize stronger monetary policy response in Brazil?," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 5(1).
    • Handle: RePEc:eee:lajcba:v:5:y:2024:i:1:s2666143824000012
    DOI: 10.1016/j.latcb.2024.100119
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    More about this item

    Keywords

    DSGE; Inflation dynamics; Optimal monetary policy; Forecasting and simulation; Bayesian estimation;
    All these keywords.

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • J6 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers

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