TIME-VARYING ASYMMETRIC PREFERENCES IN THE CENTRAL BANK OF BRAZIL’S LOSS FUNCTION

Abstract

This paper estimates a forward-looking reaction function with time-varying parameters to examine changes in the coefficients measuring asymmetries in the preferences of the Central Bank of Brazil (CBB) and verify nonlinearities in the monetary rule arising from the convexity of the Phillips curve. To consider the problem of the endogeneity in the regressors, the two-step procedure proposed by Kim (2006) and Kim and Nelson (2006) is used. The results indicate that: a) the reaction of the Selic rate to the interaction between deviation of inflation and the output gap is not statistically different from zero, suggesting that the nonlinear response of the CBB to inflation and/or output does not follow the convexity Phillips curve; b) in general, the CBB showed an asymmetric preference in favor of an above-target inflation over the period 2002-2005; c) the coefficient measuring the preference asymmetric with respect to the output gap shows a decreasing trend, but it is not statistically significant.