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Modelling the Second-Round Effects of Supply-Side Shocks on Inflation

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  • Tibor Hledik
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    Abstract

    Since the introduction of inflation targeting in the Czech Republic in 1998, supply-side factors have had a strong direct influence on CPI inflation on several occasions. This paper uses a small-scale dynamic rational expectations model based on an open-economy version of Fuhrer- Moore-type staggered wage setting to quantify the second-round effects of selected supply-side shocks and of shocks to the nominal exchange rate on wages and subsequently on inflation. In order to analyse the desired reaction of the central bank to these shocks, optimal time-consistent policy rules are derived within the presented New-Keynesian framework. Impulse response analyses are then carried out to demonstrate the model's dynamics under various policy rules corresponding to different loss functions of the central bank. The conclusions presented in the paper suggest that the second-round effects of shocks to import prices and the nominal exchange rate on inflation should not be ignored in practical policy-making.

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    Bibliographic Info

    Paper provided by Czech National Bank, Research Department in its series Working Papers with number 2003/12.

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    Date of creation: Dec 2003
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    Handle: RePEc:cnb:wpaper:2003/12

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    Keywords: monetary policy; optimal policy rules; inflation targeting.;

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    References

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    1. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination In Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
    2. Nicoletta Batini & Andrew G Haldane, 1999. "Forward-looking rules for monetary policy," Bank of England working papers 91, Bank of England.
    3. Blake, Andrew P & Westaway, Peter F, 1996. "Credibility and the Effectiveness of Inflation Targeting Regimes," The Manchester School of Economic & Social Studies, University of Manchester, vol. 64(0), pages 28-50, Suppl..
    4. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
    5. Mervyn King, 1996. "How should central banks reduce inflation? - Conceptual issues," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 25-52.
    6. Batini, Nicoletta & Yates, Anthony, 2003. " Hybrid Inflation and Price-Level Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(3), pages 283-300, June.
    7. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
    8. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    9. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
    10. Mervyn King, 1996. "How should central banks reduce inflation? conceptual issues," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 53-91.
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    Cited by:
    1. Yuliya Rychalovska, 2007. "Welfare-Based Optimal Monetary Policy in a Two-Sector Small Open Economy," Working Papers 2007/16, Czech National Bank, Research Department.
    2. Kamil Dybczak & David Vonka & Nico van der Windt, 2008. "The Effect of Oil Price Shocks on the Czech Economy," Working Papers 2008/5, Czech National Bank, Research Department.

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