Preferences of the central bank of Brazil under the inflation targeting regime: commitment vs. discretion

Abstract

This work aims to estimate the preferences of the Central Bank of Brazil during the inflation targeting regime, using a standard new keynesian model with forward-looking expectations, as proposed by Givens (2010). The presence of rational expectations in the model makes a distinction between two modes of optimization, commitment and discretion, and thus allows us to evaluate which of these specifications is favored by the data. Using quarterly data for the period from 2000-1 to 2010-4, the obtained results allow us to affirm that the data favor a discretionary policy. Estimates of the loss function show that the monetary authority gives great weight to inflation stabilization, followed by interest rate smoothing and stabilization of the output gap. O objetivo principal deste trabalho é estimar as preferências do Banco

Preferences of the Central Bank of Brazil under the inflation targeting regime: Estimation using a DSGE model for a small open economy

“…This topic has been investigated only recently for the Brazilian caseand, to the best of our knowledge, only two studies estimated the preferences of the Central Bank of Brazil: Aragon and Portugal (2009) and Palma and Portugal (2011). The present study innovatesin relation to both by considering a DSGE model and extending the work of Palma and Portugal (2011), for a small open economy. Additionally, the use of the exchange rate variable in the Central Bank's loss function isa noveltyfor the Brazilian case.…”

“…The major aim of this paper was to estimate the Central Bank preferences using a DSGE model for a small open economy, based chiefly on the work of Kam, Lees and Liu (2009). This topic has been investigated only recently for the Brazilian caseand, to the best of our knowledge, only two studies estimated the preferences of the Central Bank of Brazil: Aragon and Portugal (2009) and Palma and Portugal (2011). The present study innovatesin relation to both by considering a DSGE model and extending the work of Palma and Portugal (2011), for a small open economy.…”

“…One of them consists in including some elements of the SAMBA model, notably an equation for the inflation targetthat best describes the behavior of the Brazilian economy. In addition, as Palma and Portugal (2011) did, a version of the commitment model could be estimatedso as to check which of the two cases (commitments × discretion) best suits the Brazilian case.…”

“…In the original model, monetary policy is described by an empirical Taylor rule. FollowingIlbas (2010a, 2010b),and mainlyKam, Lees and Liu (2009), this hypothesis will be abandoned and we will assume that the monetary authority optimizes a quadratic loss function in a discretionary fashion,in accordance with the results obtained by Palma and Portugal (2011). This implies that the monetary authority reoptimizes the loss functionin each period, taking the agents' expectations as given.…”

“…However, the results did not vary significantly. 3 A discretionary environment was chosen, a priori, considering the results obtained byPalma and Portugal (2011).…”