Ex-ante dynamics of real effects of monetary policy Theory.pdfVIP

Equation Chapter 1 Section 1 Wojciech W. Charemza*) and Svetlana Makarova**) Ex-ante dynamics of real effects of monetary policy: Theory and evidence for Poland and Russia, 2001-2003 *) National Bank of Poland and University of Leicester, UK **) European University at St. Petersburg, Russia and National Bank of Poland Revised version September 2005 Acknowledgement Financial support of INTAS programme No. 03-51-3714 Nonstationary multivariate and nonlinear econometric models: theory and applications is gratefully acknowledged. We are grateful to Oleg Zamulin, workshop discussant of the paper and to other participants for their comments and discussion. We are also indebted to Kevin Lee for his constructive remarks on an earlier draft of the paper. We are solely responsible for all remaining deficiencies. Abstract The paper proposes a new indicator of expected real effects of a policy aimed at controlling inflation. The indicator, called real effect of inflation targeting (REIT), involves the comparison of expected and output-neutral inflation. It is shown that it can be derived from a simple two-dimensional vector autoregressive model of inflation and output gap. The microdynamics of such a model are explained in terms of the foundations of Taylor-type staggered wage contracts. It is assumed that the monetary authority has some discretion regarding the timing of monetary actions. Here REIT can be used to set the optimal times for such actions, if the control of output is regarded as a secondary policy target.