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Allan Dizioli and Hou Wang
This paper estimates a standard Dynamic Stochastic General Equilibrium (DSGE) model that includes a wage and price Phillip's curves with different expectation formation processes for Brazil and the USA. Other than the standard rational expectation process, we also use a limited rationality process, the adaptive learning model. In this context, we show that the separate inclusion of a labor market in the model helps to anchor inflation even in a situation of adaptive expectations, a positive output gap and inflation above target. The estimation results show that the adaptive learning model does a better job in fitting the data in both Brazil and the USA. In addition, the estimation shows that expectations are more backward-looking and started to drift away sooner in 2021 in Brazil than in the USA. We then conduct optimal policy exercises that prescribe early monetary policy tightening in the context of positive output gaps and inflation far above the central bank target.
Luis-Felipe Zanna and Mr. Marco Airaudo
Empirical evidence suggests that goods are highly heterogeneous with respect to the degree of price rigidity. We develop a DSGE model featuring heterogeneous nominal rigidities across two sectors to study the equilibrium determinacy and stability under adaptive learning for interest rate rules that respond to inflation measures differing in their degree of price stickiness. We find that rules responding to headline inflation measures that assign a positive weight to the inflation of the sector with low price stickiness are more prone to generate macroeconomic instability than rules that respond exclusively to the inflation of the sector with high price stickiness. By this we mean that they are more prone to induce non-learnable fundamental-driven equilibria, learnable self-fulfilling expectations equilibria, and equilibria where fluctuations are unbounded. We discuss how our results depend on the elasticity of substitution across goods, the degree of heterogeneity in price rigidity, as well as on the timing of the rule.
Luis-Felipe Zanna and Mr. Marco Airaudo

appropriate inflation measure of the rule should (i) shield the economy against fluctuations driven by self-fulfilling expectations 3 —Keynes’ animal spirits—and (ii) ensure that even if agents are boundedly rational—in the sense of adaptive learning as proposed by Evans and Honkapohja (2001) —they can still learn the monetary policy targeted equilibrium so the economy will converge to it. 4 Specifically, we develop a two-sector New-Keynesian DSGE model to study the determinacy and learning stability (E-stability) properties of Rational Expectations Equilibria (REE) for

International Monetary Fund. Research Dept.

Abstract

Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than seen in several decades. The cost-of-living crisis, tightening financial conditions in most regions, Russia’s invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on the outlook. Global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023. This is the weakest growth profile since 2001 except for the global financial crisis and the acute phase of the COVID-19 pandemic. Global inflation is forecast to rise from 4.7 percent in 2021 to 8.8 percent in 2022 but to decline to 6.5 percent in 2023 and to 4.1 percent by 2024. Monetary policy should stay the course to restore price stability, and fiscal policy should aim to alleviate the cost-of-living pressures while maintaining a sufficiently tight stance aligned with monetary policy. Structural reforms can further support the fight against inflation by improving productivity and easing supply constraints, while multilateral cooperation is necessary for fast-tracking the green energy transition and preventing fragmentation.

International Monetary Fund. Research Dept.

Abstract

The authors of this chapter are Mehdi Benatiya Andaloussi, Benjamin Carton (co-lead), Christopher Evans, Florence Jaumotte, Dirk Muir, Jean-Marc Natal (co-lead), Augustus J. Panton, and Simon Voigts, with support from Carlos Morales, Cynthia Nyakeri, and Yiyuan Qi. They thank Jean Pisani-Ferry for helpful comments on an earlier draft.

International Monetary Fund. Research Dept.

Abstract

The authors of this chapter are Mehdi Benatiya Andaloussi, Benjamin Carton (co-lead), Christopher Evans, Florence Jaumotte, Dirk Muir, Jean-Marc Natal (co-lead), Augustus J. Panton, and Simon Voigts, with support from Carlos Morales, Cynthia Nyakeri, and Yiyuan Qi. They thank Jean Pisani-Ferry for helpful comments on an earlier draft.

International Monetary Fund. Research Dept.