Appendix: I The Standard Model 9
1. The standard model, presented in Berg, Karam, and Laxton (2006a, b), has four behavioral equations, which feature both variables in terms of deviations from equilibrium values, i.e., as gaps, and in levels:
Appendix :II The Model
1. Our model of inflation with endogenous credibility has the following main components:
2. We explain each of these components below.
Argov, E., N. Epstein, P. Karam, D. Laxton, and D. Rose, 2007, “Endogenous Monetary Policy Credibility in a Small Macro Model of Israel,” International Monetary Fund Working Paper No. 07/207 (Washington: International Monetary Fund).
Berg, A., P. Karam and D. Laxton, 2006a, “A Practical Model-Based Approach to Monetary Policy Analysis: Overview,” International Monetary Fund Working Paper No. 06/80 (Washington: International Monetary Fund).
Berg, A., P. Karam and D. Laxton, 2006b, “A Practical Model-Based Approach to Monetary Policy Analysis: A How-To Guide,” International Monetary Fund Working Paper No. 06/81 (Washington: International Monetary Fund).
Kamenik, O., H. Kiem, and V. Klyuev, D, Laxton, 2008, “Why is Canada’s Price Level so Predictable?” IMF Working Paper 08/25 (January 2008), available at www.imf.org.
Roger, S. and M. Stone, 2005, “On Target?: The International Experience with Achieving Inflation Targets.” IMF Working Paper 05/163.
This paper was prepared by Ali Alichi, Marshall Mills, Douglas Laxton, and Hans Weisfeld.
Examples of countries that have introduced inflation-reduction targets are Brazil, Canada, Chile, Colombia, Czech Republic, Hungary, Israel, Korea, Mexico, New Zealand, Peru, Poland, and the United Kingdom (Mishkin and Schmidt-Hebbel, 2001, Table 2).
Examples are the Reserve Bank of New Zealand, the Norges Bank, the Riksbank, and the Czech National Bank.
See for example Kamenik and others (2008) and International Monetary Fund, 2006, Country Report No. 06/229, pp. 12-17 (Washington), http://www.imf.org/external/pubs/cat/longres.cfm?sk=19354.0
For details of the two models, see Appendices I and II, and the forthcoming IMF Working Paper, titled “Disinflation under an Inflation-Forecast-Targeting Regime.”
The model was formulated in close cooperation with the authorities but is the sole responsibility of IMF staff; it does not reflect the conclusions of BoG analysis.
This was end-April 2008 inflation (year-on-year).
Results for this case are not reported but are available from the authors.
The inflation target is defined as the mid-point of the targeting range.
We can think of inflation as specified in equations 6 and 7 to evolve according to a first-order, stationary autoregressive process, reverting in the long run to a targeted level of inflation in the ‘L’ case and 10.8% in the ‘H’ case. The parameter values on lagged inflation are indicative of the rate of convergence to the steady state with high persistence values implying a longer time to converge.
This term is the expectation error of the low hypothetical inflation expectation.
The convergence rate parameter of the credibility stock was calibrated to 0.7, i.e., it takes 1.5-2.0 years for credibility to rebuild from some below-full level of initial credibility.
Clear evidence of inflation bias stemming from a credibility problem is seen in the behavior of the inflation premium in the UK bond market before 1997 (World Economic Outlook, op cit.).
Representations such as this one are usually motivated with a first-order condition consistent with optimizing consumers with habit formation. See Smets and Wouters (2003) or Laxton and Pesenti (2003) for a linearized version of the Euler equation for consumption that depends on lagged and expected consumption, real interest rates and a habit-persistence parameter. However, habit persistence alone cannot account for a very large weight on the lagged output gap, which is resolved in DSGE models by adding investment to the model and significant adjustment costs associated with changing the levels of investment.
On these lines, Woodford (2003) argues that a strategy of gradual interest adjustment may be optimal.
Cardarelli, Roberto, Elekdag, Selim, and Kose, M. Ayhan, “Managing Large Capital Inflows,” Chapter 3, IMF World Economic Outlook, October 2007.
Ishii, Shogo and Habermeier, Karl, “Capital Account Liberalization and Financial Sector Stability,” IMF Occasional Paper 211, 2002.
Nakagawa, Shinobu and Psalida, L. Effie, “The Quality of Domestic Financial Markets and Capital Flows,” Chapter 3, IMF Global Financial Stability Report, September 2007.
Opoku-Afari, M., “Capital Flows and Current Account Sustainability: The Ghanaian Experience,” Bank of Ghana Working Paper (WP/BOG-2005/16), 2005.
Wakemann-Linn, Johnet al., “Private Capital Flows to Sub-Saharan Africa: Financial Globalization’s Final Frontier,” Chapter 3, IMF Regional Economic Outlook: Sub-Saharan Africa, April 2008.
Yartey, Charles Amo, “The Stock Market and the Financing of Corporate Growth in Africa: The Case of Ghana,” IMF Working Paper WP/06/201, 2006.
This paper has been prepared by Marshall Mills.
Ghana is most comparable to more recent recipients of private capital flows like Kenya, Senegal, Tanzania Uganda, and Zambia. South Africa and Nigeria are much larger economies with longer histories of private capital flows.
The data on capital inflows, and especially portfolio inflows, has weaknesses on both levels and composition. Portfolio investment is reported as “other private capital flows,” and other reliable data is limited to nonresident purchases of government securities on the primary market. The Bank of Ghana is developing a survey tool to strengthen the data, with support from the IMF. In addition, the Foreign Private Capital Capacity Building Programme (FPC CBP) is planning a study of Ghana that includes surveys of inflows. Given the increasing importance of portfolio investment, these efforts are important.