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Central Bank of Brazil reaction function: an empirical analysis using regime switching models

Grant number: 18/16842-4
Support type:Scholarships in Brazil - Scientific Initiation
Effective date (Start): January 01, 2019
Effective date (End): February 28, 2019
Field of knowledge:Applied Social Sciences - Economics
Principal Investigator:Leandro dos Santos Maciel
Grantee:Ângelo Augusto Bonvenuto
Home Institution: Universidade Federal de São Paulo (UNIFESP). Campus Osasco. Osasco , SP, Brazil

Abstract

This project aims to investigate the Central Bank of Brazil monetary policy considering its reaction function for the period since the establishment of the inflation-targeting regime in 1999 to May 2018, in which the Brazilian basic interest rate, Selic, reached its lowest level in the last 30 years. The Central Bank of Brazil reaction function will be estimated according to a forward looking Taylor's rule for an open economy, and as in addition to the variables traditionally used such as inflation and output gap, it also will consider the real exchange rate. The reaction function will be estimated in a Markov regime switching framework, in order to identify the occurrence, duration and transition probabilities of possible different regimes in the monetary policy conduction by the Central Bank of Brazil. The approach also allows for the possibility of nonlinearities in the reaction function. Thus, this methodology will provide the evaluation of a possible change in the pattern of monetary policy conducted by the monetary authorities in Brazil, especially in the recent context of a considerable fall in the Selic rate, a fundamental variable for the country's economy. Finally, through this approach, it will be possible to measure the coherence of the Brazilian monetary authority's actions with its main objective, i.e. the inflation-targeting system, as its non-commitment can contribute to the deviation of inflationary expectations from the target by the agents, resulting in a costly adjustment process and the subsequent resumption of publicly announced targets.