Identifying the effects of inflation targeting: A structural approach

This dissertation examines the impact of the inflation targeting monetary policy adopted in Canada in the last decade. Chapter I develops a structural approach to show that the shift in the inflation process and in the inflation-output trade-off which occurred in Canada after 1991 was the result of the shift in the management of monetary policy, rather than the consequence of favorable macroeconomic conditions. Using a sticky price-sticky wage model and data on output, inflation, exchange and interest rates, I filter out the historical series of exogenous shocks that affected the economy since 1991, conditional on the model being an accurate description of the economy. I compare the economy's performance under the inflation targeting regime with its counterfactual performance under the previous monetary policy. The results suggest that: (i) the shifts in the inflation dynamics and output-inflation trade-off since 1991 would not have happened under the pre-1991 monetary policy; (ii) the disinflation in the early 1990s occurred at a cost of a significant output loss; (iii) monetary policy shocks played a small role in accounting for the business cycle in Canada since 1991. Chapter II asks what is the relevance of the Bank of Canada's credibility as inflation-targeter to the economy stabilization attained in the last decade. This chapter discusses how agents' expectations about monetary policy affect the outcome of an inflation targeting regime. I build the counterfactual path of the Canadian Economy since 1991 under the assumption that the policy regime shift announced by the monetary authority was not believed by the public. In this way it is possible to quantitatively evaluate how much the change in the behaviour of the interest rate (a shift in policy) accounted for the inflation stabilization since 1991, and how much of the inflation stabilization is instead owed to the credible announcement of an inflation target (a shift in the policy rule). Chapter III provides a discussion of the methodology used to build the model-consistent counterfactuals of the Canadian economy.