Inflation targeting and inflation deviation inertia: a study for Brazil based on the fractional integration approach

Abstract

We applied the fractional integration approach to measure inflation deviation inertia in an emerging economy under an inflation targeting regime, as well as to control for potential determinants of such a deviation. We did not base our analysis on typical unit root tests, as we identified a long-memory behavior in inflation deviation. Such a non-conventional procedure can be regarded as a contribution to the inflation targeting literature. From ARFIMA and ARFIMAX estimates, we identified that inflation deviation was mainly determined by a strong inertia degree (AR(1)), commodity prices, nominal exchange rate and economic activity over the entire sample. Moreover, we found an increase of the inflation deviation inertia over the last years of our time sample, thereby indicating a deterioration of the inflation targeting regime in such a specific period.

Monetary and Fiscal Policies Interaction in a Large Emerging Economy: Which Is the Leader Policy?

“…In turn, we allowed for an inertial inflationary component (0.8 for 𝑏 𝑝𝑡−1,𝑝 ), i.e., an effect of the lagged inflation rate on the current level. Such a parameter was built on the findings of Moreira et al (2018). At last, we also included a smoothing component into the interest rate dynamics, following the adopted central value (0.9 for 𝑏 𝑟𝑡−1,𝑟 ) in the structural model of the Brazilian Central Bank (Central Bank of Brazil, 2020).…”

Why is inflation targeting adopted?

“…Diaz-Roldan, Ferrari-Filho, and da Silva Bichara (2019) showed that adoption of a adequate fiscal policy rule leads to rationalizing fiscal consolidation with IT. Moreira, Monte, and Abdala (2018) found that inflation deviation from the target level in Brazil was determined by commodity prices, nominal exchange rate, and economic performance.…”