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A Simple Model for Inflation Targeting in Brazil

  • Paulo Springer de Freitas
  • Marcelo Kfoury Muinhos
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    Based on a 6 equation model by Haldane and Battini (1999), we estimated a Phillips and an IS equations for Brazil after the Real Plan, in order to study the transmission mechanism of the monetary policy. The results show that interest rate affects output gap with a lag of one quarter and output is positively related to inflation with a one lag only. The devaluation of the nominal exchange rate has also a contemporaneous effect on inflation. We also made stochastic simulations in order to depict the inflation and output gap volatility loci under alternative Taylor-type rules and under an optimal rule, which minimizes a loss function that depends on a weighted average of inflation and output gap variances. The stochastic simulation showed that when compared to the variance in inflation, output gap variance appears to be more sensitive to the weights given in the loss function. It also showed that optimization procedures longer than 6 periods are inefficient and the most efficient frontier horizons are set within the range of 2 to 4 periods. Finally, sub-optimal but simple rules, like Taylor type rules can perform as well as the optimal ones, depending on the parameters chosen and on the preferences of the Central Bank.

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    File URL: http://www.bcb.gov.br/pec/wps/ingl/wps18.pdf
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    Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 18.

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    Date of creation: Apr 2001
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    Publication status: Published in Economia Aplicada (Brazilian Journal of Applied Economics), Vol. 6, no. 1 (Jan-Mar 2002): 31-48.
    Handle: RePEc:bcb:wpaper:18
    Contact details of provider: Web page: http://www.bcb.gov.br/?english

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