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A win-win monetary policy in Canada

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  • Oleg Kitov
  • Ivan Kitov

Abstract

The Lucas critique has exposed the problem of the trade-off between changes in monetary policy and structural breaks in economic time series. The search for and characterisation of such breaks has been a major econometric task ever since. We have developed an integral technique similar to CUSUM using an empirical model quantitatively linking the rate of inflation and unemployment to the change in the level of labour force in Canada. Inherently, our model belongs to the class of Phillips curve models, and the link between the involved variables is a linear one with all coefficients of individual and generalized models obtained by empirical calibration. To achieve the best LSQ fit between measured and predicted time series cumulative curves are used as a simplified version of the 1-D boundary elements (integral) method. The distance between the cumulative curves (in L2 metrics) is very sensitive to structural breaks since it accumulates true differences and suppresses uncorrelated noise and systematic errors. Our previous model of inflation and unemployment in Canada is enhanced by the introduction of structural breaks and is validated by new data in the past and future. The most exiting finding is that the introduction of inflation targeting as a new monetary policy in 1991 resulted in a structural break manifested in a lowered rate of price inflation accompanied by a substantial fall in the rate of unemployment. Therefore, the new monetary policy in Canada is a win-win one.

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Paper provided by arXiv.org in its series Papers with number 1103.5994.

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Date of creation: Mar 2011
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Handle: RePEc:arx:papers:1103.5994

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  1. Jeremy M. Piger & Robert H. Rasche, 2008. "Inflation: Do Expectations Trump the Gap?," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 4(4), pages 85-116, December.
  2. Rudd, Jeremy & Whelan, Karl, 2005. "New tests of the new-Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(6), pages 1167-1181, September.
  3. Ivan O. Kitov & Oleg I. Kitov & Svetlana A. Dolinskaya, 2008. "Inflation as a function of labor force change rate: cointegration test for the USA," Papers 0811.0892, arXiv.org.
  4. Benati, Luca, 2009. "Are 'intrinsic inflation persistence' models structural in the sense of Lucas (1976)?," Working Paper Series, European Central Bank 1038, European Central Bank.
  5. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  6. James Rossiter, 2005. "Measurement Bias in the Canadian Consumer Price Index," Working Papers, Bank of Canada 05-39, Bank of Canada.
  7. Ivan O. KITOV & Oleg I. KITOV, 2010. "Dynamics Of Unemployment And Inflation In Western Europe: Solution By The 1- D Boundary Elements Method," Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 5(2(12)/Sum), pages 94-113.
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