Uncovering the Hit List for Small Inflation Targeters: A Bayesian Structural Analysis


  • The authors thank the editor, Masao Ogaki, and an anonymous referee for their comments that have helped improve the paper. Timothy Kam thanks the Reserve Bank of New Zealand for its hospitality while part of the paper was written there, and acknowledges the support of the ANU Faculty of Economics and Commerce FIGS. The authors acknowledge the support of the ANU Supercomputer Facility in making their Linux cluster available. We thank Heather Anderson, Thomas Lubik, Troy Matheson, Warwick McKibbin, Kristoffer Nimark, Adrian Pagan, Simon Potter, Bruce Preston, Farshid Vahid, and seminar participants at WMD2006, ESAM06, the ANU School of Economics, UWA, and the RBA for their input and suggestions. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Reserve Bank of New Zealand.


We estimate underlying structural macroeconomic policy objectives of three of the earliest explicit inflation targeters within the context of a small open economy dynamic stochastic general equilibrium model. We assume central banks set policy optimally, such that we can reverse engineer policy objectives from observed time series data. Joint tests of the posterior distributions of these policy preference parameters suggest that the central banks are very similar in their overall objective. None of the central banks show a concern for stabilizing the real exchange rate. All three central banks share a concern for minimizing the volatility in the change in the nominal interest rate. We also show that the resulting optimal policy rule responds to exchange rate movements, even in the case where the central banks do not explicitly care about exchange rate stabilization. This result is also corroborated by results from an alternative simple-rule characterization and estimation of central bank behavior. These last two findings point to the pitfalls of making inferences, from the level of ad hoc simple rules, about what central banks may care about.