WITHOUT NEGLECTING THE ECONOMIC GROWTH: MONETARY POLICY, CREDIBILITY, AND INFLATION TARGETING IN AN IS-MP MODEL
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- Cuthbert Preston
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1 WITHOUT NEGLECTING THE ECONOMIC GROWTH: MONETARY POLICY, CREDIBILITY, AND INFLATION TARGETING IN AN IS-MP MODEL Hldr Frrira d Mndonça Gabril Caldas Mons TD. Msrado m Economia Aplicada FEA/UFJF 03/009 Juiz d Fora 009
2 Wihou Nglcing h Economic Growh: Monar Polic, Crdibili, and Inflaion Targing in an IS-MP Modl Hldr Frrira d Mndonça Fluminns Fdral Univrsi Dparmn of Economics (Brazil) and Naional Council for Scinific and Tchnological Dvlopmn (CNPq) Posal addrss: Rua Dr. Sodré, 59 Vila Suíça Migul Prira Rio d Janiro CEP: Brazil mail addrss: hldrfm@homail.com Gabril Caldas Mons Fluminns Fdral Univrsi Dparmn of Economics (Brazil) Posal addrss: Tv. Dos Ourivs, 55 Pndoiba, Nirói Rio d Janiro CEP: Brazil mail addrss:gabrilmons@homail.com Absrac This aricl shows h ffc causd b crdibili on inrs ra sings in an conom wih inflaion arging. Wih his innion, i is prsnd a horical modl which aims a showing h implicaions of crdibili for an opimal monar polic srag (hrough inrs ra sings) implmnd b an inflaion arging cnral bank. I is argud ha whn crdibili incrass i rquirs smallr inrs ra variaions in ordr o conrol inflaion and kp i convrging o h arg. In addiion, his sud analzs h impacs of crdibili and monar polic hrough inrs ra sings, on invsmn and, consqunl, on oupu quilibrium. Th findings indica ha whn crdibili is high (low) h public is inclind o bhav forward-looking (backward-looking). Concrning inflaion arging srag, a forward-looking bhavior suggss ha inflaion xpcaions ar mor anchord o h inflaion arg maning ha h srag is srving is nds. Las bu no las, a high crdibili implis a low crowding ou ffc, which in urn conribus o a mor fficin fiscal polic (lss loss in h oupu du o an incras in h inrs ra). K words: inflaion arging, monar polic, inrs ra, crdibili, oupu. JEL classificaion: E4, E5.
3 . Inroducion Macroconomic hor is moving oward a nw consnsus rgarding h rol of monar polic and how cnral banks should ac considring a world surroundd b uncrainis. Sinc h conribuions of Fridman (968), Kdland and Prsco (977) and Barro and Gordon (983a and 983b), cnral banks amp o ac hrough rulbasd policis in ordr o avoid h problms of im inconsisnc and loss of crdibili as wll as o rduc uncrainis. Th concp of crdibili is conrovrsial and has diffrn inrpraions in conomic liraur. According o Blackburn and Chrisnsn (989), crdibili can b undrsood as blifs abou h currn and fuur courss of h conomic policis, which ar consisn wih h program originall announcd b policmakrs. Drazn (000) prsns wo disinc concps abou crdibili: h crdibili of h policmakr and h crdibili of h polic. Th firs mans ha h policmakr will amp o do xacl wha h sas, whil h scond could b hough of as h xpcaion ha polic will b carrid ou. In a gnral wa, monar polic is considrd crdibl if h cnral bank follows a rul (or a srag) which is no subjc o h dnamic inconsisnc problm. Taking ino considraion an inflaion arging ssm, h public s xpcaions hav a crucial rol. In pracic, h mos usd ani-inflaionar poliical rul has bn h announcmn of inrvals for inflaion flucuaion. In ordr o improv crdibili and hus h abili o guid public s xpcaions, h cnral bank amps o dvlop and srngh is rpuaion. Th basic ida is ha wih a high rpuaion, h accurac of h public s inflaion forcas is improvd and, as a consqunc, cnral bank s accounabili is incrasd. In ohr words, rpuaion and crdibili can considrabl amliora h ffcivnss of monar polic sinc h incras h confidnc of h public on xpcaions rgarding fuur cnral bank s acions. As poind ou b Drazn (000, p. 68): A br wa of hinking abou rpuaion is in rms of an infrnc problm in forming xpcaions of a policmakr s fuur acions. ( ) Sinc w mak infrncs abou fuur bhavior basd on wha has bn obsrvd in h pas, h focus is on how pas obsrvd acions lad on o xpc fuur bhavior of a givn sor, ha is, srv o build a rpuaion for fuur acions. For an analsis of his liraur, s Goodfrind and King (997), Svnsson, (999a, 999b, 003), Woodford (007), and Goodfrind (007). 3
4 Du o h fac ha h cnral bank can influnc h forward-looking bhavior of h public in ordr o affc h conomic prformanc hrough is policis, rpuaion prforms a rlvan rol in his framwork. Undr his prspciv, polic signals from crdibl monar auhoriis (wih high rpuaions) will b br undrsood b h public impling a mor ffciv monar ransmission mchanism (hrough xpcaions) and a lowr cos of disinflaion. This aricl shows h ffc causd b crdibili on inrs ra sings in an conom wih xplici inflaion arging. As Goodfrind (007, p. 63) srssd: crdibili mus anchor inflaion xpcaions so ha a cnral bank can manipula ral inrs ras rliabl wih a nominal inrs ra polic insrumn o manag aggrga dmand. In his sns, i is prsnd a horical modl which aims a showing h implicaions of crdibili for an opimal monar polic srag hrough inrs ra sings implmnd b an inflaion arging cnral bank. I is argud ha whn crdibili incrass i rquirs smallr inrs ra variaions in ordr o conrol inflaion and kp i convrging o h arg. Morovr, his sud also analzs h impacs of crdibili and monar polic hrough inrs ra sings, on invsmn and, consqunl, on oupu quilibrium. Th rmaindr of his aricl is organizd in h following wa. Th scond scion prsns h imporanc of crdibili for monar polic. Th hird scion approachs h rol of inflaion arging cnral banks, prsns a modl rgarding h rol of monar polic hrough an opimal inrs ra srag undr an xplici flxibl inflaion arging rgim, and analzs h influnc of crdibili for his opimal polic. Th fourh scion prsns h implicaions of crdibili and h opimal monar polic for h oupu quilibrium, highlighing h bhavior of aggrga dmand. Finall, h fifh scion prsns h concluding rmarks.. Inflaion arging faurs In conras o simpl polic ruls, h inflaion arging allows h cnral bank o us h insrumns oghr wih all rlvan informaion o achiv h arg. Furhrmor, his monar rgim nabls h us of discrionar policis wihou impling a loss of crdibili. In ohr words, inflaion arging rprsns a cas whr hr is consraind discrion, as poind ou b Brnank (003, p. ): Undr consraind discrion, h cnral bank is fr o do is bs o 4
5 sabiliz oupu and mplomn in h fac of shor-run disurbancs, wih h appropria cauion born of our imprfc knowldg of h conom and of h ffcs of polic (his is h "discrion" par of consraind discrion). Howvr, a crucial proviso is ha, in conducing sabilizaion polic, h cnral bank mus also mainain a srong commimn o kping inflaion and, hnc, public xpcaions of inflaion firml undr conrol (h consraind par of consraind discrion). Th nw macroconomic consnsus implis ha h ffc causd b monar polic managmn on ral acivi ma no b nglcd. Goodfrind and King (997) highligh boh posiiv and normaiv implicaions. In rlaion o h posiiv viw, conomic flucuaions ar associad wih monar polic. Basd on normaiv prspciv, aggrga dmand mus b managd b monar polic in ordr o rach fficin macroconomic oucoms. In shor, nowadas a s of characrisics is considrd ssnial for a good prformanc of cnral banks in h conducion of h monar polic, which in urn srnghns h choic of an inflaion arging rgim as a nominal anchor. Mishkin (000) highlighs svn poins: (i) pric sabili should b h ovrriding, long-run goal of monar polic; (ii) an xplici nominal anchor should b adopd; (iii) a cnral bank should b goal dpndn; (iv) a cnral bank should b insrumn indpndn; (v) a cnral bank should b accounabl; (vi) a cnral bank should srss ransparnc and communicaion, and; (vii) a cnral bank should also hav h goal of financial sabili. Inflaion arging rgim has as is main faur h official announcmn of rangs for inflaion flucuaions and h xplici rcogniion ha h main objciv of h monar polic is o assur a low and sabl inflaion ra. Morovr, his monar rgim conribus o rduc uncrainis abou h goals and insrumns of monar polic wihou prcluding polic acivism, and provids a srag ha allows for h pursui of objcivs ohr han pric sabili in a mor disciplind and consisn mannr. Inflaion arging hlps o rduc uncrain abou h fuur cours of inflaion and guids xpcaions bcaus i provids monar polic wih a nominal anchor and improvs h cnral bank ransparnc. Sinc inflaion arging rprsns a srag concrnd wih bringing boh inflaion and inflaion xpcaions o h announcd arg as wll as rducing h For an analsis rgarding inflaion arging, cnral bank ransparnc and hir ffcs on inrs ra, s d Mndonça and Simão Filho (007), Mons (008), and Oriro and Nvs (008). 5
6 uncrainis and boh sacrific raios and oupu volaili, his framwork pushs cnral banks o dvlop crdibili in ordr o improv h public s xpcaions. Hnc, i is xpcd ha crdibl inflaion args srnghn forward-looking bhavior on h simaion of inflaion and hus wakn h wigh of pas inflaion. In ohr words, inflaion xpcaions pla a fundamnal rol in his nvironmn. Thrfor, basd on an inflaion arging ssm, crdibili is crucial for is succss, bcaus i hlps incrasing h spd of convrgnc of inflaion xpcaions o h inflaion arg. Nowihsanding, i is imporan o no ha crdibili is buil ovr im. As a consqunc, inflaion arging will no rduc inflaion xpcaions quickl, bu rahr i will do so graduall ovr im. 3. Opimal inrs ra rul undr inflaion arging Aiming a analzing h consqunc of h crdibili on public s xpcaions and hus on monar polic, a horical modl is dvlopd in ordr o prsn h inrs ra sing b h cnral bank in h managmn of h monar polic aking ino accoun an xplici flxibl inflaion arging rgim. 3 A firs sp in h modl is o show how h oupu () is influncd b h ral inrs ra (r) and b h xpcaions of h public rgarding oupu variaion (E( )). Thrfor, i is assumd ha () = A E ( ) δ r, δ > 0 whr A is h sum of xognous muliplid-up dmands. I is imporan o highligh ha a divrgnc bwn h xpcd inrs ra and h quilibrium inrs ra implis non-ngligibl ffcs on oupu xpcaions. Whn h xpcd inrs ra is lowr han h quilibrium inrs ra, h ffc on h xpcd oupu variaion is posiiv (h conrar is also ru). Hnc, () E ( ) = X b[ E ( r ) ] r, whr, X is a vcor of xplanaor variabls. Th modl considrs h possibili of diffrnc bwn h currn oupu and h ponial oupu ( ). In quilibrium, h ffcs causd b xpcaions ar 3 Rcn mpirical analsis for h Brazilian cas shows ha highr crdibili implis lowr variaions in h inrs ra for conrolling inflaion (s d Mndonça, 007; and d Mndonça and d Guimarãs Souza, G.J., 009). 6
7 ngligibl and h oupu is dfind b h inrs ra ha qualizs o, ha is, (3) = A δ r. Taking ino accoun quaions () and (3), h oupu gap is givn b (4) = E ( ) δ ( r r ). Th inrpraion of h quaion abov is ha h oupu gap dpnds on boh divrgncs bwn h xpcd ral inrs ra and h quilibrium inrs ra (s quaion ) and bwn obsrvd inrs ra of h prvious priod and h quilibrium inrs ra. In his modl h priva conom is rprsnd b an augmnd Phillips curv (backward-looking) wih inflaion inria ffcs. Morovr, h Phillips curv quaion rprsns a consrain o h modl and rvals h rad-off bwn inflaion and oupu gap. (5) π = θπ ( θ ) E ( π ) α( ) ε, ε ~ N(0,σ ), 0 < θ < and α > 0. According o quaion (5), inflaion a ( π ) dpnds on: pas inflaion (inria); inflaion xpcaion buil a - for inflaion a priod ; and h oupu gap a priod - which mans ha if h cnral bank innds o rduc inflaion, h cos of disinflaion is no ngligibl. 4 Th modl assums ha h social wlfar funcion is givn b h cnral bank loss funcion, suggsing ha h cnral bank is concrnd wih inflaion and oupu. Hnc, (6) L λ π π whr, λ > 0 T = ( ) ( ) λ rprsns h wigh cnral bank givs o oupu gap. Th jusificaion for h us of h doubl lag iming assumpions and hncπ mach h viw of h Bank of England (999). According o Carlin and Soskc (006, p. 53): Th doubl lag srucur ( ) mphasizs ha a dcision akn oda b h cnral bank o rac o a shock will onl affc h inflaion ra wo priods lar ( ). Whn h conom is disurbd in h currn priod (priod zro), h cnral bank looks ahad o h implicaions for inflaion and ss h inrs ra so as o drmin, which in urn drmins h dsird valu of π. Sinc h cnral 4 Th opion for a linar Phillips curv rahr han a non-linar or an asmmric on is sufficin for h purpos of his aricl. Hnc, i is imporan o clarif ha is simplici dos no affc h rsuls of his modl. 7
8 bank can onl choos and π b is inrs ra dcision, is loss funcion aks h form prsnd hrough quaion (6). Wih h objciv o find h opimal monar polic, h subsiuion of quaion (5) ino quaion (6) is mad and h rsul is minimizd wih rspc o, ha L T is, = ( ) ( ) 0 α π π λ = T λ (7) ( π ) = ( ) π. α. Thus, h opimal monar rul corrsponds o Making us of quaion (5) h abov quaion bcoms λ T (8) ) α = [ θπ ( θ ) E ( π π ] rwrin as: (9) (0) ( ) α Taking ino considraion quaions (4) and (5) h rsul abov ma b λ α E ( ) δ( r r ) = α T θ θπ ( θ) E ( π) α( ) ( θ) E ( π ) π. Rarranging h quaion abov o find opimal inrs ra srag, hn r E r = ( ) α T ( ) ( ) ( ) ( ) ( ) { θ E π θe π θ π π θα }. δ δ α λ Sinc h currn inrs ra affcs h conom wih lags, and ha his ffc on oupu occurs bfor h ffc on inflaion du o h ransmission mchanism of monar polic, h loss funcion ma b rwrin as L λ, which in urn, implis ha h prvious quaion T = ( ) ( π π ) corrsponds o. () ( r r ) = E ( ) α δ δ ( α λ ) { ( ) ( ) ( ) ( )} T θ E π θe π θ π π θα, or ( r r ) = { ( ) ( ) ( ) ( )} T γ E ( ) τ θ E π θ E π θ π π θα whr, δ α = τ and γ δ =. ( α λ) 8
9 Th quaion abov rprsns an opimal inrs ra rspons for an inflaion arging cnral bank (MP curv in h modl). 5 I capurs h ida sad b Zimmrmann (003) ha h cnral bank uss all availabl informaion rgarding currn and fuur courss of boh inflaion and h ral sid of h conom in an amp o sabiliz inflaion and h oupu gap a h sam im. Furhrmor, i is imporan o no ha du o h laggd ffcs of monar polic, h cnral bank, for insanc, nds o rac o inflaion forcass. If h inflaion forcas indicas ha inflaion will ris, h cnral bank should rais inrs ra bfor acual inflaion sar o ris and vic-vrsa. Th inrs ra srag rprsnd b quaion () spcifis h magniud in which h inrs ra mus b changd in racion o changs in inflaion ra, inflaion xpcaions, xpcaions of fuur oupu chang, and oupu gap. Morovr, whn a dcras in inflaion followd b mporar oupu losss is a rsul of cnral bank s rsponss, h inrs ra rul is opimal in h sns ha marginal uili and marginal cos of monar polic acions ar qualizd. Equaion () allows obsrving imporan implicaions for h analsis rgarding h ffcs from crdibili o h opimal monar polic. In his sns, h paramrs θ andτ pla a crucial rol in his analsis (schm shows h cass of low and high crdibili and is implicaions for h monar polic managmn). Whn hr xiss a high (low) crdibili h public will bhav basd on a forward-looking (backwardlooking) mannr. Thus, aking ino considraion θ, i is obsrvd ha a smallr (largr) valu implis ha inflaion xpcaions bcom mor rlvan han currn inflaion for h inrs ra rspons. I is imporan o srss ha a high crdibili allows h cnral bank aks ino accoun in is racion funcion boh dparurs of inflaion from inflaion arg and oupu gap. In ohr words, h cnral bank s bhavior is closr o flxibl inflaion arging srag han sric inflaion arging srag (s schm ). Du o a srag clos o flxibl inflaion arging (sric inflaion arging) implis high (low) valus of α, λ, and δ, h consqunc is a low (high) τ. In brif, a low (high) valu of τ implis a wak (srong) racion of inrs ra. 5 MP curv is h cnral bank racion as suggsd b Romr (000). 9
10 Schm Effcs from crdibili Crdibili High Low Forward looking bhavior Backward looking bhavior θ θ rspons E(π) rspons π rspons E(π) rspons π Flxibl IT Sric IT High α, λ, δ Low α, λ, δ Low τ High τ (r - r) as monar polic (r - r) igh monar polic 4. Aggrga dmand, quilibrium, and monar polic In ordr o undrsand how h monar polic affcs aggrga dmand, h drminaion of consumpion and invsmn ar fundamnal (Romr, 00). Thrfor, invsmn and consumpion funcions ar prsnd and h oupu quilibrium is analzd aking ino considraion wo disinc cass: (i) crdibili bing 0
11 buil - as a consqunc, i aks mor im and ffor o sabiliz h conom (low crdibili), and; (ii) dvlopd crdibili hrfor h ask of monar polic bcoms asir and wih lss coss for h soci (high crdibili). 4.. Invsmn, consumpion, and quilibrium Th modl of aggrga dmand is basd on Fazzari, Frri and Grnbrg (008). In his sns, h basic invsmn funcion is givn b I η 0 η E η = E CF 3r E ( p ) η, () [ ( ) ] [ ( )] whr: I rprsns h ral lvl of invsmn ha is ralizd a h nd of priod. Th rm η 0 can b inrprd as rplacmn invsmn, assuming gomric dprciaion and a consan capial-oupu raio (wih a dprciaion ra of υ and a capial-oupu raio ofϕ, and η0 = υϕ ). Th rm η E ( ) ] follows from h acclraor [ modl, whr h acclraor rlas h ral lvl of invsmn o h xpcd chang in ral oupu bwn priod and - concrning informaion a -. Th rm η [ ( ) ] ( ) E CF E p rprsns h influnc of xpcd nominal cash flow, ha is, h xpcd availabili of inrnal rsourc, for h invsmns; h xpcd nominal cash flow E ) is dflad b h xpcd pric lvl E ) o ( CF ( p corrspond o ral invsmn. 6 Th rm ( η r 3 ) follows from h radiional rlaion bwn ral inrs ra and invsmn. 7 Considring E ( ) g = as h xpcd conomic growh ra bwn priod - and, hus quaion () can b rwrin as, I η 0 η g η = E CF 3r E ( p ) η. (3) [ ( )] I is imporan o no ha h xpcd nominal cash flow rsuls from h 6 As Fazzari, Frri and Grnbrg (008, p. 559) poind ou: Grar cash flow raiss h amoun of invsmns ha firms can undrak wihou incurring h risks and coss associad wih db or nw shar issus. 7 I is imporan o srss ha diffrn from h cas which h inrs ra affcs h oupu wih a lag, h acual inrs ra is rlvan for currn invsmn dcisions.
12 diffrnc bwn h xpcd nominal rvnu [ E ( p ) E ( ) ] and h xpcd wag bill [ E ( W ) ] addd o h xpcd nominal inrs coss [ E ( R ) D ], hn,8 E ( CF ) = E ( p ) E ( ) E ( W ) E ( R ) D. (4) Assuming a consan wag shar in xpcd nominal aggrga incom dnod b w, his implis ha E ( W ) = w[ E ( p ) E ( )], and hus h quaion abov corrsponds o, 9 E ( CF ) = ( w)[ E ( p ) E ( )] E ( R ) D. (5) Making h subsiuion of (5) ino (3), h invsmn funcion bcoms, D (6) I η 0 η g η ( w) E ( ) η = E ( R ) 3r E ( p ) η. Rwriing h invsmn funcion in an innsiv form, hn I E ( ) D (7) i = = η0 ηg η( w) ηe ( R ) η3r.. Y E ( p ) E ( ) Du o h fac ha, = ( g ) and = ( g ), quaion (7) bcoms D (8) i η η 0 g η ( w)( g )( g ) η = E ( R ) 3r E ( p ) η. incom, hn Assuming h raio of bginning of priod nominal db o laggd nominal D D d = and, consqunl, d =. As a consqunc, h p p invsmn quaion in is innsiv form ma b wrin as (9) i = η0 ηg η( w)( g )( g ) ηe ( R ) d η3r E ( p ) p p i = η0 ηg η µ ( g ) ηe ( R ) d η3r, E ( p ) whr i is assumd ha µ = w and = ( g ). Basd on quaion (9), whil an incras in xpcd growh ra conribus o an incras in invsmn, an incras in ral inrs ra rducs i. Th rms bwn 8 Whr ( D ) is h prdrmind nominal sock of db ousanding a h bginning of priod, ha is, D = D ( r ) p I CF. 9 This assumpion, according o Fazzari, Frri and Grnbrg (008), is consisn wih a fixd mark-up modl of pricing ha ariss from monopolisic compiion.
13 bracks dsrv h following obsrvaions: (i) Sinc D = and, D = D ( R ) p I CF, hn, d is known in priod and d p affcs invsmns invrsl in his priod; (ii) Whn g raiss, invsmns incras, and whn incrass, d dcrass; p (iii) Wih rspc o h raio, i is assumd ha whn E ( p ) incrass, p E ( p ) raiss b a largr proporion, and hn invsmns rduc. I happns bcaus, basd on highr xpcaions abou fuur prics, h priva scor sars a dfnsiv procss in rgards o prsn incom b raising is prics, which lads o a gnralizd incras of currn prics, and hn of p in a highr proporion han E ). This siuaion ( p cras uncrainis in h conom which caus invsmn rducions. In addiion, whn p sars o incras (lading o an acclraion of h inflaion ra) h public cras xpcaions for a highr ral inrs ra bcaus i knows ha h monar auhori will rac (raising h nominal inrs ra) agains h inflaionar procss, as wll as agains h drioraion of inflaion xpcaions, if boh hran h inflaion arg; hnc, E ) will also incras. ( R In ordr o xprss h muliplir ffc, a simpl consumpion funcion, whr aggrga disposabl incom ( ψ ) xplains aggrga consumpion xpndiurs, is prsnd. In his funcion C 0 rprsns h auonomous consumpion and C h avrag marginal propnsi o consum, hnc: (0) C = C ( ) 0 C ψ, whr, C 0 >0, 0 < C <, and 0 <ψ <. b, 0 I is considrd ha oupu is drmind b dmand and h quilibrium is givn () = C I A. Subsiuing (0) ino () and dividing h rsul b laggd oupu, hn C 0 C ( ψ ) () g = = i a. Making h subsiuion of quaion (9) ino (), h rsul is givn b 0 A rprsns h sum of govrnmn xpndiurs (G) wih n forign xpndiurs (X-M) and hus A = G X M. For is urn, a = A, c0 = C0, and i is assumd ha n forign incom is zro. 3
14 p η µ ( g ) η E ( R ) d C Cψ (3) = ( η0 η g a c0 η3r ) E ( p ) = p η µ ( g ) η E ( R ) d ( ψ ) C E ( p ) whr β = a c0. ( η0 ηg β η3r ) Equaion (3) rprsns h IS curv in h modl. Th main causs of changs in h muliplir (h raio bwn bracks) ar: (i) h firs rm is [ η µ ( g ) ] whr an incras (dcras) in h xpcaion of fuur conomic growh ( g ) implis an incras (dcras) in h muliplir; (ii) h scond rm η E ( R ) d p E ( p ) indicas ha whn h pric xpcaion is lowr han h xpcaion concrning h nominal inrs ra, h rsul is an incras in h xpcaion of h ral inrs ra which in urn implis an incras in h db srvic of firms, and hn, a dcras in h muliplir; (iii) h hird rm [ ( ψ ) C ] mans ha an incras (dcras) in h marginal propnsi o consum or a dcras (incras) in axaion (ψ ) amplifis (rducs) h muliplir. I mus b highlighd ha hs causs drmin h slop of h IS curv. Du o h rlvanc of crdibili in h managmn of h monar polic, xpcaions prform a crucial rol in h modl. Furhr, xpcaions ar fundamnal in h dcision-making procss of invsmn. Undr his nvironmn govrnmn announcmns rgarding public invsmns ar capabl of affcing xpcaions (for xampl, xpcd conomic growh ra). Thrfor, among h variabls of quaion (3), g bcoms fundamnal for xplaining shifs of h IS curv. Assuming ha h govrnmn announcs ha will mak nw infrasrucur invsmns, posiiv public s xpcaion rgarding a susainabl conomic growh is a consqunc (maning ha g, g > 0 ). Basd on quaion (3) whnvr g incrass hr xiss an incras in priva invsmn (I ). This incras in aggrga invsmn I is assumd ha h ffc causd b h xpcd inrs ra on h ral inrs ra is dirc. 4
15 implis dmand and produciv capaci ffcs, affcing boh oupu and inflaion. 4.. Dmand shocks, crdibili, and growh Assuming a posiiv shock on boh g and g causd b govrnmn announcmns of nw infrasrucur invsmn, h IS curv shifs for h righ and bcoms flar promoing an incras in h aggrga dmand. Thrfor h conom movs from poin A o poin B (s figur ). As a consqunc of h dmand ffc an inflaionar prssur is crad (oupu Y is grar han h original ponial oupu Y 0 ), which will impl a cnral bank racion incrasing h inrs ra in ordr o miiga his prssur. I mus b nod ha h magniud of h cnral bank rspons dpnds on h lvl of is crdibili (s schm ). Figur Effcs of crdibili on IS-MP modl r MP Low r Low r High r 0 C Low A C High MP High B IS IS 0 Y 0 Y Low Y Y High Y I is imporan o highligh ha in conras wih h parn modls concrning h subjc, his modl considrs ha h crowding ou ffc is parial. Th jusificaion is ha h capaci ffc promos an incras in h ponial oupu (givn b rgarding MP High, and Y High Y Low rgarding MP Low ) which drmins h nw inrs ra of 5
16 quilibrium ( r High or r Low, rspcivl). Hnc, hough h nw quilibrium prsns a highr inrs ra, an conomic growh is obsrvd. I mus b srssd ha h quilibrium can b changd du o diffrn lvls of crdibili (high and low drmining poins CHigh and C Low ). According o schm, cnral bank s rsponss hrough inrs ra ar lss aggrssiv whn crdibili is high (which mans a flar MP curv MP High bcaus h paramr τ is lowr). Thrfor, hrough quaion (3), if rsponss hrough inrs ra ar wakr, h impacs on oupu will b lowr. I also suggss ha boh monar polic and oupu ar bcoming lss volail. As a consqunc, basd on h analsis rgarding h influnc of crdibili for h opimal monar polic, as wll as on quaion (3) which modls h oupu bhavior, i is possibl o argu in favor of h imporanc xrd b crdibili for h oupu growh. 5. Conclusion This sud prsnd a horical analsis rgarding h ffcs of crdibili on h opimal monar polic. Th findings indica ha whn crdibili is high (low) h public is inclind o bhav forward-looking (backward-looking). Concrning inflaion arging srag, a forward-looking bhavior suggss ha inflaion xpcaions ar mor anchord o h inflaion arg maning ha h srag is srving is nds. In h cas of high crdibili, inflaion xpcaions ar mor rlvan han currn and pas inflaion for h cnral bank s racion. As a consqunc, wihou abandoning h focus on pric sabili, h monar polic is lss igh han in h cas of low crdibili and hus h impac on h oupu is anuad. Hnc, whn crdibili is highr, boh inrs ra and oupu ar lss volail. This analsis also approachs h magniud of h impacs of fiscal policis (announcmns) on h conom aking ino accoun h crdibili of h monar polic. Undr his viw, a high crdibili implis a low crowding ou ffc, which in urn conribus o a mor fficin fiscal polic (lss loss in h oupu du o an incras in h inrs ra). 6. Rfrncs BANK OF ENGLAND (999) Th ransmission of monar polic. 6
17 hp:// BARRO, R.J. and GORDON, D. B. (983a) A Posiiv Thor of Monar Polic in a Naural Ra Modl. Journal of Poliical Econom, 9(4), (983b) Ruls, Discrion and Rpuaion in a Modl of Monar Polic. Journal of Monar Economics, (), 0-. BERNANKE, B.S. (003) A Prspciv on Inflaion Targing. A h Annual Washingon Polic Confrnc of h Naional Associaion of Businss Economiss, Washingon, D.C., March 5. hp:// BLACKBURN, K. and CHRISTENSEN, M. (989) Monar Polic and Polic Crdibili: Thoris and Evidnc. Journal of Economic Liraur, 7(), -45. CARLIN, W. and SOSKYCE, D. (006) Macroconomics: Imprfcions, Insiuions, and Policis. Oxford Univrsi Prss. d MENDONÇA, H.F. (007) Towards Crdibili from Inflaion Targing: h Brazilian Exprinc, Applid Economics, 39(0), d MENDONÇA, H.F. and d GUIMARÃES SOUZA, G.J., (009) Inflaion arging crdibili and rpuaion: Th consquncs for h inrs ra, Economic Modlling, doi:0.06/j.conmod d MENDONÇA, H.F. and SIMÃO FILHO, J. (007) Economic Transparnc and Effcivnss of Monar Polic. Journal of Economic Sudis, 34(6), DRAZEN, A. (000) Poliical Econom in Macroconomics. Princon Univrsi Prss. FAZZARI, S.; FERRI, P.; GREENBERG, E. (008) Cash flow, invsmn, and Kns-Minsk ccls. Journal of Economic Bhavior & Organizaion, 65(3-4), FRIEDMAN, M. (968) Th Rol of Monar Polic. Th Amrican Economic Rviw, 58(), -7. GOODFRIEND, M. and KING, R. G. (997) Th nw noclassical snhsis and h rol of monar polic. In Bn Brnank and Julio Rombrg, ds., NBER Macroconomics Annual. Cambridg, Ma: MIT Prss. GOODFRIEND, M. (007) How h World Achivd Consnsus on Monar Polic. Journal of Economic Prspcivs, (4), KYDLAND, F.E. and PRESCOTT, E. C. (977) "Ruls Rahr han Discrion: h Inconsisnc of Opimal Plans". Journal of Poliical Economic, 85(3), MISHKIN, F. S. (000) Wha Should Cnral Banks Do? Fdral Rsrv Bank of S. Louis Rviw, Novmbr/Dcmbr. MONTES, G. C. (008) Mas d Inflação m Prspciva: a influência do rinômio rpuação-crdibilidad-ransparência sobr a conomia. Rvisa d Economia Políica, 8(4), OREIRO, J. L. C. and NEVES, A. L. O rgim d mas d inflação: uma abordagm órica. Ensaios FEE, 9(), 0-3. ROMER, D. (00) Advancd Macroconomics. Scond Ediion, McGraw-Hill.. (000) Knsian macroconomics wihou h LM curv. Journal of Economic Prspcivs, 4(), SVENSSON, L. (003) Wha is wrong wih Talor ruls? Using judgmn in monar polic hrough arging ruls. Journal of Economic Liraur, 4(), (999a) Inflaion Targing as Monar Polic Rul. Journal of Monar Economics, 43(3), (999b) How Should Monar Polic B Conducd in an Era of Pric 7
18 Sabili? Procdings, Fdral Rsrv Bank of Kansas Ci, WOODFORD, M. (007) Th Cas for Forcas Targing as a Monar Polic Srag. Journal of Economic Prspcivs, (4), 3-4. ZIMMERMANN, G. (003) Opimal Monar Polic: A Nw Knsian Viw. Quarrl Journal of Ausrian Economics, 6(4),
CHAPTER CHAPTER14. Expectations: The Basic Tools. Prepared by: Fernando Quijano and Yvonn Quijano
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