Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil

de Sá, Rodrigo and Savino Portugal, Marcelo (2015): Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil. Published in: Economic Modelling , Vol. 51, (December 2015): pp. 72-83.

Abstract

Whether central banks place the same weights on positive and negative deviations of inflation and of the output gap from their respective targets is an interesting question regarding monetary policy. The literature has sought to address this issue using a specific asymmetric function, the so-called Linex loss function. However, is the Linex an actually asymmetric specification? In an attempt to answer this question, we applied the sieve estimation method, a fully nonparametric approach, in which the result could be any proper loss function. This way, our results could corroborate the quadratic or Linex loss functions used in the literature or suggest an entirely new function. We applied the sieve estimation method to the United States and to Brazil, an emergent country which has consistently followed an inflation targeting regime. The economy was modeled with forward-looking agents and central bank commitment. Our results indicate that the FED was more concerned with inflation rates below the target, but no asymmetry was found in the inflation–output process in the Volcker–Greenspan period. As to Brazil, we found asymmetries in output gaps from 2004 onwards, when the Brazilian Central Bank was more concerned with positive output gaps; but we did not find any statistically significant asymmetries in inflation.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy; Central bank's preference; Asymmetric preferences; Sieve estimators
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

C. Ai and X. Chen. Efficient estimation of models with conditional moment restrictions containing unknown functions. Econometrica, 71(6):1795–1843, 2003.

E.K.S.B. Aragón and M.S. Portugal. Nonlinearities in Central Bank of Brazil’s reaction function: the case of asymmetric preferences. Estudos Econômicos, 40(2):373–399, 2010.

M. Baxter and R. King. Measuring business cycles: Approximate band-pass filters for economic time series. Review of Economics and Statistics, 81(4):575 – 593, 1999.

X. Chen. Large sample sieve estimation of semi-nonparametric models. Handbook of Econometrics, 6:5549–5632, 2007.

X. Chen and S.C. Ludvigson. Land of addicts? An empirical investigation of habit-based asset pricing models. Journal of Applied Econometrics, 24(7):1057–1093, 2009.

X. Chen and X. Shen. Sieve extremum estimates for weakly dependent data. Econometrica, 66(2): 289–314, 1998.

C. Chiarella, P. Flaschel, G. Gong, and W. Semmler. Nonlinear phillips curves, complex dynamics and monetary policy in a keynesian macro model. Chaos, Solitons & Fractals, 18(3):613–634, 2003.

R. Clarida, J. Galí, and M. Gertler. The science of monetary policy: A new keynesian perspective. Journal of Economic Literature, 37:1661–1707, 1999.

R. Clarida, J. Gali, and M. Gertler. Monetary policy rules and macroeconomic stability: Evidence and some theory. Quarterly Journal of Economics, 115(1):147–180, 2000.

Richard Clarida, Jordi Galı, and Mark Gertler. Monetary policy rules in practice: some interna- tional evidence. european economic review, 42(6):1033–1067, 1998.

Agostino Consolo and Carlo A Favero. Monetary policy inertia: More a fiction than a fact? Journal of monetary economics, 56(6):900–906, 2009.

A. Cukierman and V.A. Muscatelli. Do central banks have precautionary demands for expansions and for price stability?: Theory and evidence. CESifo Working Paper Series, 764, 2002.

J.J. Dolado, R. Maria-Dolores, and M. Naveira. Are monetary-policy reaction functions asymmet- ric?: The role of nonlinearity in the phillips curve. European Economic Review, 49(2):485–503, 2005.

U. Grenander. Abstract inference. John Wiley & Sons, 1981.

J.D. Hamilton. A parametric approach to flexible nonlinear inference. Econometrica, 69(3):537– 573, 2001.

K.L. Judd. Numerical methods in economics. The MIT press, Cambridge, 1998.

Dong Heon Kim, Denise R. Osborn, and Marianne Sensier. Nonlinearity in the Fed’s monetary policy rule. Journal of Applied Econometrics, 20(5):621–639, 2005.

Fiodendji Komlan. The asymmetric reaction of monetary policy to inflation and the output gap: Evidence from canada. Economic Modelling, 30:911–923, 2013.

L. Ljungqvist and T.J. Sargent. Recursive macroeconomic theory. The MIT press, Cambridge, 2004.

Ruthira Naraidoo and Leroi Raputsoane. Optimal monetary policy reaction function in a model with target zones and asymmetric preferences for south africa. Economic Modelling, 28(1): 251–258, 2011.

A. Robert Nobay and David A. Peel. Optimal discretionary monetary policy in a model of asym- metric central bank preferences. The Economic Journal, 113(489):657–665, 2003.

AR Nobay and D.A. Peel. Optimal monetary policy with a nonlinear phillips curve. Economics Letters, 67(2):159–164, 2000.

A. Orphanides and V. Wieland. Inflation zone targeting. European Economic Review, 44(7): 1351–1387, 2000.

Brian Sack and Volker Wieland. Interest-rate smoothing and optimal monetary policy: a review of recent empirical evidence. Journal of Economics and Business, 52(1):205–228, 2000.

E. Schaling. The nonlinear phillips curve and inflation forecast targeting: Symmetric versus asym- metric monetary policy rules. Journal of Money, Credit, and Banking, 36(3):361–386, 2004.

Paolo Surico. The Fed’s monetary policy rule and U.S. inflation: The case of asymmetric prefer- ences. Journal of Economic Dynamics and Control, 31(1):305 – 324, 2007.

L.E.O. Svensson and M. Woodford. Implementing optimal policy through inflation-forecast tar- geting. The inflation-targeting debate, 1:19 – 92, 2005.

J.B. Taylor. Discretion versus policy rules in practice. In Carnegie-Rochester conference series on public policy, volume 39, pages 195–214. Elsevier, 1993.

M. Woodford. Interest and prices: Foundations of a theory of monetary policy. Princeton Univ Press, Princeton, 2003.

Michael Woodford. Optimal monetary policy inertia. Working Paper 7261, National Bureau of Economic Research, July 1999. URL http://www.nber.org/papers/w7261.