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An Estimated (Closed Economy) Dynamic Stochastic General Equilibrium Model for the Philippines: Are There Credibility Gains from Committing to an Inflation Targeting Rule?

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  • Majuca, Ruperto P.
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    Abstract

    We use Bayesian methods to estimate a medium-scale closed economy dynamic stochastic general equilibrium (DSGE) model for the Philippine economy. Bayesian model selection techniques indicate that among the frictions introduced in the model, the investment adjustment costs, habit formation, and the price and wage rigidity features are important in capturing the dynamics of the data, while the variable capital utilization, fixed costs, and the price and wage indexation features are not important. We find that the Philippine macroeconomy is characterized by more instability than the U.S. economy. An analysis of the several subperiods in Philippine economic history also reveals some quantitative evidence that risk aversion increases during crisis periods. Also, we find that the inflation targeting (IT) era is associated with a more stable economy: the standard deviations of the technology shock, the risk-premium shock, and the investment-specific technology shock have significantly lower variability than the pre-IT era, with the last two shocks being reduced by a factor of 5.6 and 2.3, respectively. The IT era is also associated with lower risk aversion. We also find that the adoption of inflation targeting is associated with interest rate smoothing in the monetary reaction function. With a more inertial reaction function, the Bangko Sentral ng Pilipinas (BSP) had achieved greater credibility and consequently, it was able to manage the expectations of forward-looking economic actors, and thereby achieved greater responses of the goal variables to the policy rates, even if the size of interest rates changes are smaller. However, we also find that BSP`s conduct of monetary policy appears to be more procyclical than countercyclical, particularly during the Asian financial crisis, and the recent global financial and economic crisis.

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    Bibliographic Info

    Paper provided by Philippine Institute for Development Studies in its series Discussion Papers with number DP 2011-04.

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    Length: 70
    Date of creation: 2011
    Date of revision:
    Handle: RePEc:phd:dpaper:dp_2011-04

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    Keywords: monetary policy; inflation targeting; Philippines; dynamic stochastic general equilibrium (DSGE); new Keynesian model; Bayesian estimation;

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    References

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    1. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, American Economic Association, vol. 97(3), pages 607-635, June.
    2. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
    3. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco.
    4. Erceg, Christopher & Guerriei, Luca & Gust, Christopher, 2006. "SIGMA: A New Open Economy Model for Policy Analysis," MPRA Paper 813, University Library of Munich, Germany.
    5. Charlotta Groth & Hashmat Khan, 2010. "Investment Adjustment Costs: An Empirical Assessment," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 42(8), pages 1469-1494, December.
    6. Christoffel, Kai & Coenen, Günter & Warne, Anders, 2008. "The New Area-Wide Model of the euro area: a micro-founded open-economy model for forecasting and policy analysis," Working Paper Series, European Central Bank 0944, European Central Bank.
    7. Malin Adolfson & Michael K. Andersson & Jesper Lindé & Mattias Villani & Anders Vredin, 2007. "Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 3(4), pages 111-144, December.
    8. Aldaba, Rafaelita M., 2010. "Does Trade Protection Improve Firm Productivity? Evidence from Philippine Micro Data," Discussion Papers, Philippine Institute for Development Studies DP 2010-32, Philippine Institute for Development Studies.
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