Targets and Inflation Dynamics
Brazil has experienced crucial changes in its inflation process since the adoption of inflation targeting in mid 1999. This article addresses changes in the analytical framework employed to track the inflation dynamics, specifically the relevance of an explicit target for inflation. A New-Keynesian Phillips curve (NKPC) is derived incorporating indexation not only to past inflation but also to inflation targets, generalizing the Woodford (2003) hybrid curve. In our modeling, firms that do not optimally set their prices in a given period adjust them only by indexing their previous prices to a weighted average of the inflation target and lagged inflation. In such a framework, the impact of inflation targets on agents' decisions regarding the supply side can be analytically measured by the parameter associated to the inflation target. It is shown that inflation target affects the welfare-based monetary policy objective function by penalizing deviations of actual inflation from target instead of from zero. This result establishes the micro foundation basis for ad-hoc loss functions as indicated in traditional literature. Therefore, the inflation target also affects the optimal target criterion. We also present a microfounded specification to model inflation expectations, and conclude that when firms attribute a high weight to the government's inflation target when setting their own prices, exchange rate and demand shocks are unable to alter significantly inflation expectations. Such a result gives some light to empirical ad hoc assessment conducted in traditional literature. Our empirical evidence shows that even after major shocks, the target ability of anchoring inflation has been restored. Although not formally tested, such a fact followed the monetary authorities' firm commitment to meet the inflation targets, reinforced by the government's necessary support through a consistent fiscal policy.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Laurence M. Ball & Niamh Sheridan, 2004.
"Does Inflation Targeting Matter?,"
NBER Chapters,in: The Inflation-Targeting Debate, pages 249-282
National Bureau of Economic Research, Inc.
- Laurence Ball & Niamh Sheridan, 2003. "Does Inflation Targeting Matter?," NBER Working Papers 9577, National Bureau of Economic Research, Inc.
- Laurence Ball & Niamh Sheridan, 2004. "Does inflation targeting matter?," DNB Staff Reports (discontinued) 118, Netherlands Central Bank.
- Niamh Sheridan & Laurence M. Ball, 2003. "Does Inflation Targeting Matter?," IMF Working Papers 03/129, International Monetary Fund.
- Norman Loayza & Raimundo Soto, 2002. "Inflation Targeting: An Overview," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.), Inflation Targeting: Desing, Performance, Challenges, edition 1, volume 5, chapter 1, pages 001-022 Central Bank of Chile.
- Lawrence J. Christiano & Terry J. Fitzgerald, 2003. "The Band Pass Filter," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(2), pages 435-465, May.
- Lawrence J. Christiano & Terry J. Fitzgerald, 1999. "The Band pass filter," Working Paper 9906, Federal Reserve Bank of Cleveland.
- Lawrence J. Christiano & Terry J. Fitzgerald, 1999. "The Band Pass Filter," NBER Working Papers 7257, National Bureau of Economic Research, Inc.
- Martin Cerisola & Gaston Gelos, 2009. "What drives inflation expectations in Brazil? An empirical analysis," Applied Economics, Taylor & Francis Journals, vol. 41(10), pages 1215-1227.
- Martin D. Cerisola & R. G Gelos, 2005. "What Drives Inflation Expectations in Brazil? An Empirical Analysis," IMF Working Papers 05/109, International Monetary Fund.
- Fabio Araujo & Marta Baltar Moreira Areosa & José Alvaro Rodrigues Neto, 2003. "r-filters: a Hodrick-Prescott Filter Generalization," Working Papers Series 69, Central Bank of Brazil, Research Department.
- Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One Decade of Inflation Targeting in the World: What Do We Know and What Do We Need to Know?," NBER Working Papers 8397, National Bureau of Economic Research, Inc.
- Frederic S. Mishkin & Klaus Schmidt-Hebbel, 2001. "One decade of inflation targeting in the world : What do we know and what do we need to know?," Working Papers Central Bank of Chile 101, Central Bank of Chile.
- Fabia A de Carvalho & Mauricio S. Bugarin, 2006. "Inflation Expectations in Latin America," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, vol. 0(Spring 20), pages 101-145, January.
- Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
- Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters,in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.