RDP 9807: Inflation Targeting in a Small Open Economy Appendix C: Further Results

Nargis Bharucha and Christopher Kent

July 1998

Table C1: Parameter Values
Parameter description Parameters Model A Model B Model C
Speed of exchange rate pass-through α – – 0.5
Degree of backward-lookingness λ – 0.5 0.5
Effect of traded intermediate input on non-traded
inflation		 β1
β2 		0.025
0		 0.025
0		 0.025
0
Effect of output gap on non-traded inflation α 0.2 0.2 0.2
Share of traded good in consumption basket η 0.3 0.3 0.3
Persistence of output gap μ 0.7 0.7 0.7
Sensitivity of the output gap to the real interest rate ø 0.1 0.1 0.1
Sensitivity of output gap to the relative price of
non-traded good		 γ1
γ2 		0
0.06		 0
0.06		 0
0.06
Degree of persistence in risk premium θ 0.8 0.8 0.8
Central bank's discount factor(a) δ 1.0 1.0 1.0
Preference for targeting aggregate inflation μπ 1 , 0 1 , 0 1 , 0
Preference for targeting non-traded inflation μN 0 , 1 0 , 1 0 , 1
Preference for targeting output gap μy 0.5 0.5 0.5
Preference for instrument stability μi 0 0 0
Preference for instrument smoothing μΔπ 0.01 0.01 0.01
Standard deviation of supply shock σN 1 1 1
Standard deviation of demand shock σy 1 1 1
Standard deviation of risk premium shock σρ 3 3 3

Notes: (a) Svensson (1998) shows that the optimisation problem is well-defined for δ = 1.
Figure C1: Model B – Impulse Response Functions
Figure C1: Model B – Impulse Response Functions
Figure C2: Model C – Impulse Response Functions
Figure C2: Model C – Impulse Response Functions
Figure C3: Model C, Discretionary Solution – Impulse Response Functions
Figure C3: Model C, Discretionary Solution – Impulse Response Functions
Table C2: Standard Deviations – Model B
  π πN y Δi r Δe q
  Shock Aggregate inflation targeting
Unconditional   2.84 2.14 1.56 3.59 4.56 6.45 9.88
Exchange rate 1.43 0.63 0.50 3.08 4.29 4.26 7.57
Conditional Supply 1.45 1.51 0.53 1.25 0.84 2.18 2.93
Demand 1.99 1.37 1.38 1.35 1.29 4.33 5.64
  Non-traded inflation targeting
Unconditional   3.74 1.49 1.39 5.84 5.10 11.18 10.84
Exchange rate 1.88 0.13 0.20 1.05 3.41 6.35 7.46
Conditional Supply 1.69 1.35 0.63 3.15 1.83 4.09 3.64
Demand 2.75 0.64 1.23 4.80 3.32 8.25 6.97
Table C3: Standard Deviations – Model C
  π πN y Δi r Δe q
  Shock Aggregate inflation targeting
Unconditional   1.47 1.60 1.62 3.28 4.63 5.88 9.18
Exchange rate 0.84 0.54 0.55 2.50 4.11 4.32 6.90
Conditional Supply 0.97 1.37 0.81 1.34 1.43 2.42 4.44
Demand 0.73 0.61 1.30 1.64 1.60 3.16 4.11
  Non-traded inflation targeting
Unconditional   2.03 1.24 1.33 4.02 4.97 8.97 8.47
Exchange rate 1.18 0.13 0.12 1.04 3.33 6.09 6.45
Conditional Supply 1.19 1.22 0.70 2.53 2.08 3.63 3.66
Demand 1.16 0.17 1.12 2.94 3.04 5.49 4.09
Table C4: Standard Deviations – Model C – Discretionary Solution
  π πN y Δi r Δe q
  Shock Aggregate inflation targeting
Unconditional   1.87 1.40 1.33 3.54 4.22 6.82 7.98
Exchange rate 1.02 0.16 0.29 2.24 3.56 5.03 6.63
Conditional Supply 1.25 1.33 0.51 2.04 1.34 2.56 2.67
Demand 0.94 0.40 1.19 1.83 1.84 3.83 3.55
  Non-traded inflation targeting
Unconditional   2.16 1.33 1.25 4.71 5.12 9.10 8.09
Exchange rate 1.21 0.14 0.13 1.01 3.29 6.19 6.49
Conditional Supply 1.34 1.30 0.58 3.27 2.31 3.72 2.87
Demand 1.18 0.23 1.10 3.24 3.17 5.54 3.88
Table C5: Expected Value of Central Bank Loss Function
  Aggregate inflation target Non-traded inflation target
Model A – backward-looking 11.47 6.58
Model B – forward-looking 9.41 3.55
Model C – gradual pass-through 3.60 2.58
Model C – discretionary solution 4.49 2.77