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Prepared by Giang Ho.
All variables enter the model as year-on-year growth rates, except for the short-term interest rate. Four lags are included.
The Cholesky identification scheme assumes the following order of the variables: (Δpcom, sr, Δip, Δneer, Δpimp, Δppi, Δcpi).
The triangle model refers to a Phillips Curve that depends on three elements—inertia (e.g., adaptive expectations), demand (e.g., unemployment or output gap), and supply (e.g., food and energy prices, exchange rate, productivity growth). Supply shock variables appear explicitly in the inflation equation rather than being forced into the error term as in the New Keynesian Phillips Curve approach.
The “gap” variables are measured as deviations from an HP trend.
We are grateful to the Norges Bank for providing historical series for CPI-ATE.
For the dynamic forecast, we use the WEO projection of the output gap, and project the REER and productivity gaps using an ARIMA model.
In this scenario, the (negative) output gap is wider by 0.75 percentage points relative to baseline in each quarter during the forecasting period.
This scenario assumes that the real exchange rate depreciates by an additional 5 percent in each quarter relative to baseline.