Financial openness and inflation targeting: an analysis for the unpleasant fiscal arithmetic

Transcription

1 Financial opnnss and inflaion arging: an analysis for h unplasan fiscal arihmic Hldr Frrira d Mndonça Fluminns Fdral Univrsiy Dparmn of Economics and Naional Council for Scinific and Tchnological Dvlopmn (CNPq) Addrss: Rua Dr. Sodré, 59 Vila Suíça Migul Prira Rio d Janiro CEP: 269- Brazil [email protected] Igor da Silva Viga Fluminns Fdral Univrsiy Dparmn of Economics Addrss: Rua Barão d Olivira Casro, 65 Jardim Boânico Rio d Janiro CEP: Brazil [email protected] Absrac Emrging conomis which hav adopd inflaion arging and which combin low crdibiliy, high public db, and a high inrs ra suffr from a ypical problm. Incrass in h inrs ra o rduc dparurs of inflaion from h arg imply highr primary surplus for sabilizing public db/gdp raio. This ricky siuaion is known as unplasan fiscal arihmic (UFA). This aricl dvlops a horical modl showing how an incras in financial opnnss and capial accoun libralizaion can miiga UFA. Furhrmor, mpirical vidnc from h Brazilian cas hrough OLS, GMM, and GMM sysm mhods is offrd. Th findings dno ha incrass in capial mobiliy and financial opnnss work as a commimn chnology which conribu o h succss of h inflaion arging and hus rduc h risk of UFA occurs. Ky words: financial opnnss, capial accoun libralizaion, unplasan fiscal arihmic, inflaion arging, crdibiliy, oupu. Rsumo As conomias mrgns qu adoaram o rgim d mas para a inflação qu combinam baixa crdibilidad, lvada dívida pública uma ala axa d juros sofrm d um problma ípico. Aumnos na axa d juros para conr a inflação implicam maior suprávi primário para sabilizar a razão dívida pública/pib. Essa siuação dlicada é conhcida como dsagradávl ariméica fiscal (DAF). Es arigo dsnvolv um modlo órico qu mosra como um aumno da abrura financira da libralização da cona d capiais pod anuar a DAF. Além disso, são aprsnadas vidências mpíricas para o caso brasiliro por mio d modlos MQO GMM. Os rsulados indicam qu o aumno da mobilidad d capiais a maior abrura financira funcionam como uma cnologia d compromisso capaz d conribuir para o sucsso do rgim d mas para a inflação, dssa forma, rduzir o risco d a DAF ocorrr. Palavras-chav: libralização financira, libralização da cona d capiais, dsagradávl ariméica fiscal, mas para a inflação, crdibilidad, produo. Classificação JEL: E58, E63. Ára 4 - Economia do Sor Público

2 1. Inroducion Rcnly inflaion arging has bn adopd by svral mrging conomis. 1 Th main characrisic of h inflaion arging is ha i works as a guid for h public s xpcaions. Howvr, h monary rgim fails in h ask of making h convrgnc bwn inflaion xpcaions and h inflaion arg if hr is no sufficin crdibiliy. On of h main poins for h succss of inflaion arging is h absnc of fiscal dominanc. Furhrmor, jus as in h prvious cas, monary dominanc is no dsirabl. On ypical problm of mrging conomis which hav adopd inflaion arging is ha a disinflaionary monary policy can caus a fiscal imbalanc. Th rason is ha, undr an inflaion arging rgim, inrs ra is h main insrumn availabl for h cnral bank in managing h monary policy. Morovr, in counris lik Brazil, public db is srongly indxd o h inrs ra. Thrfor, incrass in inrs ra in ordr o rach h inflaion arg imply incrass in primary surplus for sabilizing public db/gdp raio. This ricky siuaion is known as unplasan fiscal arihmic (UFA) and i is ncssary o find framworks capabl of miigaing i. In h sarch for mchanisms capabl of avoiding h inflaion bias of discrionary monary policy, financial opnnss and capial accoun libralizaion ar poind o as a soluion (Barolini and Drazn, 1997; Grubn and McLod, 21; Gupa, 28; Badingr, 29; and Spigl, 29). Th main ida is ha a grar frdom for capial flow rducs h im inconsisncy problm in monary policy. Th rason is ha a rducion in capial conrols incrass h lasiciy of subsiuion bwn h domsic and h forign currncy and hus dmands a ransparn and accounabl bhavior of h cnral bank. Hnc, on consqunc is ha a low inflaion policy by h cnral bank is mor crdibl. Thrfor, i is possibl o considr opnnss (financial and capial accoun libralizaion) as a sragy for avoiding UFA. This aricl maks a conribuion in his dircion. A horical modl is dvlopd showing how an incras in opnnss conribus o h convrgnc bwn inflaion and is arg and hus o dcras h primary surplus. Furhrmor, mpirical vidnc concrning UFA from h Brazilian cas is offrd. Bsids Brazil bing on of h mos imporan mrging conomis, h analysis for his counry is suiabl bcaus i has svral characrisics which ar propiious for analyzing an nvironmn wih UFA and h ffc causd by opnnss (inflaion arging, capial conrols had bn rducd, high inrs ra, public db is srongly indxd o h inrs ra, and cnral bank crdibiliy is sill dvloping). Bsids his inroducion, his aricl is organizd as follows. Th nx scion prsns a small survy of h rlaion bwn capial mobiliy and is ffcs on inflaion ra. Scion 3 dvlops a horical modl which considrs how an incras in financial opnnss can miiga UFA. Scion 4 shows mpirical vidnc, basd on h Brazilian cas, hrough h applicaion of ordinary las squars (OLS), gnralizd mhod of momns (GMM), and GMM sysm. Th las scion prsns h conclusion. 2. Capial mobiliy and inflaion Rogoff (23) shows ha h mark globalizaion has a doubl rol: implis a dcras in h pric of goods, and conribus o h slmn of lowr inflaion args. Furhrmor, h incras in h compiivnss incrass pric flxibiliy and hus wakns h impac of h monary policy on h conomy. As obsrvd by Obsfld and Taylor (1998), whn capial conrols ar liminad, h monary auhoriy nds o choos bwn adoping a fixd xchang ra or indpndn monary policy. Th rason is ha h combinaion of hs lmns is no fasibl. According o Dornbusch (1998), 1 S, for xampl, Brazil, Colombia, Czch Rpublic, Ghana, Guamala, Hungary, Indonsia, Mxico, Pru, Philippins, Romania, Slovak Rpublic, Souh Africa, Thailand, and Turky. 2

3 indpndnly from h xchang ra rgim, h capial accoun libralizaion is a consrain on monary policy. Th main ida is ha h conomic agns undrsand h incras in h opnnss as an incras in h cnral bank s commimn o low and sabl inflaion. As highlighd by Frankl (1999), a combinaion of adminisrd xchang ra and indpndn monary policy is fasibl bcaus hr xiss h opion of an inrmdia capial conrol (bwn oal mobiliy or oal conrol). Alhough hr xiss his possibiliy, Calvo and Rinhar (22) poind ou ha h far of floaing h xchang ra is du o h lack of h cnral bank crdibiliy. This obsrvaion is imporan bcaus in h cas of low cnral bank crdibiliy h impac of flucuaions of h xchang ra on h inflaion and on h financial sysm is no ngligibl. Focusing on h inflaion, on of h main channls for h ffc of h capial accoun libralizaion is h mony dmand lasiciy. Whn h accss o h forign currncy incrass, h possibiliy of subsiuing h domsic currncy for anohr which is mor rliabl also incrass. Thrfor, grar capial mobiliy can pnaliz h cnral bank whn i adops an inflaionary monary policy. As obsrvd by Romr (1993), counris wih grar commrcial opnnss hav lowr inflaion. Th main rason is ha a non-xpcd inflaionary policy causs currncy dvaluion and hus h pass-hrough is grar in conomis which ar mor opn. As highlighd by Wagnr (21), an incras in h opnnss implis an incras in h cos of an inflaionary policy du o h grar compiion among h counris, which in urn implis a highr risk of financial capial loss. In h sam dircion Cook (21), hrough a gnral quilibrium modl, srnghns his ida showing ha opnnss in an conomy avoids h us of an inflaionary monary policy. A good xampl of h mpirical analysis which indicas ha an incras in h capial mobiliy is associad wih a lowr inflaion is shown by Grubn and McLod (21). Ths auhors, aking ino accoun a cross scion of 1 counris, found a srong ngaiv rlaion bwn inflaion and capial accoun libralizaion. Th cnral ida is ha grar capial accoun libralizaion rsrains h inflaionary monary policy bcaus i facilias h xchangs of currncis and hus srnghns h cnral bank s commimn o low inflaion. Ths rsuls ar also obsrvd in anohr mpirical analysis mad by Gupa (28) hrough h us of dynamic panl daa modl considring 163 counris and h priod which spans from 198 o 23. Alhough h abov argumns indica ha grar capial accoun libralizaion is good for a lowr inflaion, par of h mpirical liraur shows a doub concrning h advanags of his sragy. Rodrik (1998), basd on a sampl of 1 counris for h priod from 1975 o 1989, did no find vidnc ha capial accoun libralizaion is associad wih a fall in inflaion. Th main argumn is ha fr capial mobiliy amplifis h xposur of h conomy o h xrnal shocks. Loungani, Razin and Yun (21) conclud ha h dgr of capial mobiliy is rlvan for h inflaion-oupu rad-off. In paricular, a fall in h oupu du o a fall in h inflaion is lowr in counris wih som capial conrol. Chin and Io (22) found vidnc ha h majoriy of h mrging conomis, which hav lowr capial conrols, is mor unsabl and has lowr conomic growh. Danils and VanHoos (29) obsrvd ha alhough grar capial accoun libralizaion conribus o a dcras in inflaion, i implis an incras in h sacrific raio. 3. Opnnss and h convrgnc of inflaion o h arg Th main objciv of his scion is o show a horical modl whr h opnnss (financial and capial accoun libralizaion) works as a commimn chnology which conribus o h convrgnc bwn h inflaion xpcaions and inflaion arg. 2 According o h liraur on capial accoun libralizaion, his sragy would b dsirabl bcaus i avoids h problm of im inconsisncy in h managmn of h monary policy. 3 Financial and capial accoun libralizaion cra a punishmn for h monary auhoriy in h 2 Th modl framwork is inspird by King (1995) and Rogoff (23). 3 S, Barolini and Drazn (1997), Grubn and McLod (21), and Gupa (28). 3

4 cas of an inflaionary policy. Th punishmn occurs hrough h subsiuion of currncis implying a fall in h cnral bank s rsrvs (cas of fixd xchang ra) or an incras in h inflaion du o a currncy dvaluaion (cas of flxibl xchang ra). Sinc h priva capial flows dpnd on h inflaion xpcaion, his channl implis ha h opnnss rducs h cnral bank s inflaionary bias. A basic poin for h succss of inflaion arging is ha h public blivs ha h inflaion arg will b rachd. In h sarch for his objciv, h main insrumn for h cnral bank is h inrs ra (Frdman and Ökr-Rob, 21). Howvr, h slmn of h inrs ra may considr h impac on h dynamic of h public db and h fuur prformanc of h conomy. Th us of a high inrs ra (igh monary policy) in an amp o rach h inflaion arg dmands a high primary surplus as a way o impd an xplosiv pah for h public db. On criical lmn for h succss of h inflaion arging is how h fuur inflaion xpcaions ar buil. In paricular, an incras in h public db rprsns a ponial risk of monizaion and hus, h public xpcaions concrning h achivmn of h inflaion arg ar driorad. 4 Thrfor, a igh fiscal policy which assurs h fiscal quilibrium is a mchanism for avoiding inflaionary prssur. This modl considrs an inflaion arging nvironmn. Hnc, h main objciv of h cnral bank is o rach h inflaion arg (π*). Furhrmor, h rlaion bwn housholds and firms is obsrvd hrough h labor mark. Th housholds dcid h labor supply basd on h ral wag. Thrfor, inflaion xpcaions ( π ) hav a crucial rol in his procss. Morovr, h ral wag is drminan of labor dmand by firms. Hnc, whn h inflaion (π ) is diffrn from h inflaion xpcaions h consqunc is a chang in h oupu (y ). In spcific, whn h inflaion is grar han h inflaion xpcaion ( π π > ) h rsul is an oupu grar han ha which corrsponds o h flxibl prics ( y ). Consqunly, h oupu (in logs) is givn by 2 (1) y = y + ( π π ) z z ~ N(, σ ), whr z is a random supply shock. Th monary auhoriy dfins h policy o b adopd in h priod afr h public s inflaion xpcaions in -1 and o obsrv h occurrnc of any supply shock. Th cnral bank s loss funcion (quaion 2) follows h sandard in h liraur, ha is, i considrs h dparurs of inflaion from h arg and of oupu from h socially opimal lvl. Thus, 2 2 (2) L = ( y y*) + χ( π π*), CB whr χ is a posiiv consan and givs h rlaiv wigh which h cnral bank aribus o h inflaion sabilizaion. As a mannr of considring h im inconsisncy problm du o h prsnc of an inflaionary bias in h modl, h socially opimal oupu is grar han o h full mploymn. According o Kydland and Prsco (1977) and Barro and Gordon (1983), his hypohsis is a consqunc of, for xampl, posiiv marginal axaion (h housholds do no rciv all advanags from addiional work) or imprfc compiion (firms do no rciv all advanags from addiional oupu). Hnc, y * y = k >, whr k is h cnral bank s inflaionary bias. Making h subsiuion of quaion (1) ino quaion (2) for comprhnding h inflaion s ffc on cnral bank s loss funcion, hn 2 2 (3) L = ( π π k z ) + χ( π π*). CB Assuming ha conomic agns hav raional xpcaions and know h cnral bank s loss funcion, h monary auhoriy s problm is o rach h inflaion capabl of minimizing is losss. 4 This nvironmn is mor probabl in mrging conomis wih a hisory of high inflaion whr h far of a monizaion is grar han in h cas of dvlopd counris. 4

5 Thrfor, basd on (3), h firs ordr condiion is (4) 2( π π k z ) + 2 χ( π π *) =, and hus, π + k + z + χπ * (5) π =. 1+ χ Thrfor, h monary auhoriy s opimal inflaion is a funcion of h xpcd inflaion ra. Sinc ha uncrainy is no considrd in h modl, h public prcivs h inflaion ra ha will b implmnd by h cnral bank. As a consqunc, h inflaion xpcaions buil in h priod -1 corrspond o: π + k + z + χπ * (6) π = E 1( π ) = E 1 1+ χ, as E ( ) 1 z =, xpcd inflaion is (7) π = π * + k χ. Hnc, an incras in h gap bwn h socially opimal oupu and h quilibrium wih flxibl prics (k) implis an incras in h xpcd inflaion ra. Du o h possibiliy of h cnral bank sling h inrs ra afr obsrving h public s inflaion xpcaions, h x-pos opimal rsul is diffrn from x-an and hus a dynamic inconsisncy problm is crad. In ohr words, if h cnral bank sas a inflaion arg π* and h public blivs ha his arg will b rachd, hn π = π *. Howvr, afr o know h public s xpcaions h monary auhoriy has an incniv o implmn a grar inflaion for achiving h opimal social oupu ( π > π * ). Thrfor, assuming raional xpcaions in h modl, h public s xpcaions bcom π > π *. In h sam way as abov, a grar rlaiv wigh givn by h monary auhoriy for h pric sabiliy ovr a grar oupu, h lowr is h inflaion xpcaion. In ohr words, as highlighd by Rogoff (1985) whn h public prcivs ha h monary policy is conrolld by a consrvaiv cnral bankr h rsul is a lowr inflaion xpcaion. In brif, as priva capial flows is associad wih inflaion xpcaions, i is xpcd ha and an incras in h capial accoun libralizaion dcrass h cnral bank s inflaion bias. Taking ino accoun h ffc of h capial mobiliy on h cnral bank s loss funcion, quaion (3) can b rwrin as (8) 2 2 CB = ( ) ( *) µ π π + χ π π, L k z whr µ is a posiiv consan and rfrs o h lvl of conrol on h capial accoun. Th main ida is ha h adopion of capial conrols implis an incras in h asymmric informaion bwn h cnral bank and h public. Hnc, a mark failur is crad and h consqunc is an incras in h cnral bank s inflaionary bias. Thrfor, h monary auhoriy s problm is: (9) 2 2 CB = µ π π + χ π π, and hus, h firs ordr condiion implis ha min L ( ) k z ( *) π (1) 2 µ ( π π ) k z µ + 2 χ( π π*) =, hn, 2 µ π + µ k + µ z + χπ * (11) π =. 2 µ + χ Th inflaion xpcaions buil in h priod -1 ar givn by 2 µ π + µ k + µ z + χπ * (12) π = E 1( π ) = E 1 2, and hus, inflaion xpcd is µ + χ µk (13) π = π * +. χ Th quaion abov shows an imporan implicaion. As a dcras in capial conrols lads a lowr µ, hr is an incras in h cnral bank s commimn o achiv h inflaion arg, hus 5

6 conribuing o a convrgnc bwn inflaion xpcaion and h arg. This rsul is in consonanc wih ha prsnd by Tyll and Wi (24) whr a grar capial flow promos a dcras in h inflaion ra, vn if h cnral bank is no fully commid o a low inflaion policy (k/χ > ) Opnnss and unplasan fiscal arihmic Th prvious modl is paricularly rlvan for analyzing a ypical problm in mrging conomis whr h crdibiliy is bing buil and hr is h ncssiy of a igh monary policy for assuring h convrgnc bwn h inflaion ra and h arg. In h las yars h ripod of flxibl xchang ra, inflaion arging and fiscal balanc is h rul of humb usd by svral mrging conomis. In a gnral way, hs conomis sarch for a high lvl of crdibiliy and ar subjc o h problm known as unplasan fiscal arihmic (UFA). In ohr words, whn i is ncssary o dcras inflaion and hr is no sufficin crdibiliy, h consqunc is an incras in h inrs ra, which in urn cras an incras in public db/gdp raio. Hnc, h lack of crdibiliy implis a cos which is h primary surplus ncssary o assur h fiscal balanc (King, 1995). Basd on h prvious modl and argumns prsnd in King (1995) and Rogoff (23) i is possibl o s ha h opnnss can avoid UFA bcaus i works as a commimn chnology which assurs h convrgnc of inflaion xpcaions o h arg. Hnc, assuming ha h signiorag is ngligibl and h public dfici is financd by issu of public bonds, h dynamic of public db is N (14) D = PS + r D, N whr D is h public db; PS is h primary surplus; and r is h nominal inrs ra. Dividing boh D and PS by h nominal GDP, d and ps rspcivly, quaion (14) can b rwrin as N (15) d = d ( r g π ) ps, N whr g is h conomic growh ra and π is h inflaion ra. Th par ( r g π ) givs h incras in h public db du o h inrs ra discouning h conomic growh and h inflaion ra. N Taking ino accoun h ral inrs ra ( r = r π ), quaion (15) corrsponds o (16) d = d ( r g ) + ( π π ) ps. Wih h objciv of obsrving h adopion of inflaion arging, his modl considrs an nvironmn wihou full cnral bank crdibiliy and h inflaion arg (π*) is lowr han h currn inflaion (π ). As a consqunc, h convrgnc of h inflaion o h arg aks plac in a sluggish mannr. Th cor of h ida is ha low cnral bank crdibiliy impds ha h inflaion arging works wll as a guid for inflaion xpcaions. Thrfor a low convrgnc bwn inflaion and h arg is xpcd in his cas. On h ohr hand, whil h arg is achivd ovr im h crdibiliy (α ) improvs and hus h inflaion xpcaions ar clos o h arg, hus α * * (17) π = π ( π π ). In rgard o h fiscal balanc, h primary surplus ncssary o mainain h public db/gdp raio sabl a is original lvl (d ) is * (18) ps = ( r g ) d + ( π π ) d α, whr h firs par of h righ hand sid of h quaion abov shows h ffc causd by a ral inrs ra grar han h conomic growh ra on h public db. Th scond par of h righ hand sid of h quaion apprhnds h ffc of h crdibiliy on h public db. A lowr crdibiliy implis a grar impac of h dviaions in inflaion from is arg, (19) * * d = d. lim ( π π ) ( π π ) α α 6

7 Thrfor h incras in h primary surplus ncssary o mainain consan h public db/gdp raio undr an nvironmn wihou full crdibiliy is * (2) ps = ( π π ) d α. Basd on Rogoff (23) and King (1995), capial mobiliy can works as an incras in h crdibiliy for avoiding UFA. Hnc, dparurs of inflaion xpcaions from h arg aking ino accoun h rlvanc of h opnnss corrsponds o * µk * (21) π = π ( π π ), or χ * * ( π π ) π = π, whr π = π. χ µ k Th inuiion bhind quaion (21) is similar o ha in quaion (13), ha is, opnnss conribus o h convrgnc bwn h inflaion xpcaions and h inflaion arg. Wih h objciv of obsrving h dirc ffc of capial conrols (µ) on h public s inflaion xpcaions and assuming h cnral bank s prfrnc for inflaion sabilizaion and inflaion bias consan (χ=1 and k=1), quaion (21) is simplifid o * * ( π π ) (22) π = π. 1 µ Such as prsnd in quaion (17), an incras in opnnss (β) ovr im provoks a quick adjusmn of h inflaion xpcaions o h arg, and hus: (23) * * π π π π β = ( ), whr β =1/µ. Hnc, h primary surplus o mainain h sabiliy of h public db considring h ffc of capial accoun libralizaion is * (24) ps = ( r g ) d + ( π π ) d β. Th scond par of h righ hand sid of h quaion abov indicas ha an incras in h opnnss conribus o a lowr primary surplus du o h divrgnc bwn inflaion and h arg. Hnc, in h cas of prfc capial mobiliy * (25) lim ( π ) π d β =. β Conrary o his, whn h capial accoun libralizaion is nar zro, whavr dviaion of h inflaion from h arg provoks an incras in primary surplus, hus, β * * (26) lim ( π π ) d = ( π π ) d β. Thrfor, considring an nvironmn wih imprfc capial mobiliy, h incras in primary surplus which is ncssary o mainain sabl public db/gdp is: * (27) ps = ( π π ) d β. Th quaion abov shows ha grar capial mobiliy anuas h fiscal ffor bcaus i conribus o h convrgnc of h public s inflaion xpcaions o h arg. In brif, grar opnnss srnghns h cnral bank s commimn o achiv h inflaion arg and hus rducs UFA. 4. Empirical analysis According o Sargn and Wallac (1981) h combinaion of wo facors pu in risk h conrol ovr inflaion. Th us of high inrs ras, in an amp o avoid an inflaionary prssur, implis a ngaiv impac on consumpion and invsmn which in urn dcrass h conomic growh. Anohr concrn is ha high inrs ras produc fiscal imbalancs du o h incras in h public 7

8 db. Thos poins ar crucial for h analysis on UFA bcaus i considrs an nvironmn whr h cnral bank dos no hav full crdibiliy, high inrs ras ar pracicd afr h adopion of inflaion arging, and h public db is srongly indxd o h inrs ra. Brazil posssss h abov-mniond poins and hus, indicas ha an mpirical analysis from his conomy may obsrv if h opnnss anuas h problm as indicad by h horical modl. As can b sn hrough figur 1, ovr h priod from 1999 o 21 h ral inrs ra was grar han h conomic growh ra a larg par of h im. This obsrvaion suggss an nvironmn of low cnral bank crdibiliy (high inrs ras for conrolling inflaion) wih h ncssiy of primary surpluss for avoiding an incras in h public db. 2 Figur 1 Ral inrs ra and conomic growh ra ( ) ral inrs ra conomic growh Th pah of h primary surplus is anohr lmn ha suggss ha Brazil has an nvironmn propiious for analyzing UFA. An incras in primary surplus (ngaiv valus) is obsrvd spcially afr 22 (s figur 2). Th chang in h rnd obsrvd a h nd of 28 and during 29 (shadd ara in h graph) is jusifid by h xpansionis fiscal policy adopd in rspons o h fall in h conomic growh causd by h subprim crisis. Figur 2 Primary surplus/gdp (%)

9 4.1. Opnnss undr inflaion arging Taking as rfrnc h horical modl, h opnnss can work as a ool for miigaing UFA. Th Brazilian cas is a good fi for an mpirical analysis. In January of 1999, h adopion of h flxibl xchang ra rgim combind wih a dcras in rsricions o forign capial, and h opnnss of nw forign invsmn channls, simulad h procss of capial accoun libralizaion in h counry. Sinc 2 h procss rmains hrough masurs for rducing buraucracy in h capial mark. In his sudy, wo indics of capial accoun mobiliy ar considrd. Th firs is h Financial Opnnss Indx (FOI) which corrsponds o a masurmn of h capial flow movmn monh-omonh in h Brazilian conomy ovr h priod undr analysis (July of 1999 o Spmbr of 21). Hnc, (28) FOI = ( inflow ouflow) GDP. For building h indx, daa rgarding financial and capial accoun of h Brazilian balanc of paymn mad availabl by h Cnral Bank of Brazil (CBB) is usd (s abl A.1 - appndix). Figur 3 shows h voluion of h FOI accumulad and dnos ha h priods which span from 2 o 23 and afr 26 ar markd by a rnd of libralizaion. In conras, h priod from 24 o 26 shows sagnaion in h movmn (shadd ara in h graph)..5 Figur 3 Financial opnnss indx ( ) Th scond indx considrd in his analysis is a capial conrol indx (CCI) basd on monhly dcrs (lgislaion of porfolio flow in h shor run) for h priod from July of 1999 o Spmbr of Th informaion on dcrs is mad availabl by CBB and h Brazilian Financ Minisry. Each dcr is classifid as: +1 if i indicas libralizaion; -1 if i consrains h capial flow; and if i only sandardizs or communicas a fac wihou changs in h capial flow. Figur 4 shows h voluion of h accumulad CCI and indicas ha h priods from 1999 o 22 and afr h subprim crisis h capial conrols wr rduc considrably, whil bwn 26 and 28 hr was rlaiv sagnaion (shadd ara in h graph). 5 A similar indx was buil by Cardoso and Goldfajn (1998). 9

10 5 Figur 4 Capial conrol indx ( ) Daa Wih h innion of providing mpirical vidnc from h Brazilian cas basd on h horical modl, h indicaors (monhly frquncy), mad availabl by h CBB, usd in his analysis for h priod from July 1999 o Spmbr 21 ar: 6 (i) Primary surplus (PS) his indicor is h public borrowing rquirmns wihou dvaluaion (%GDP) flows accumulad in 12 monhs primary rsul (Fdral Govrnmn and CBB). Primary surplus is h dpndn variabl in h modl. (ii) Dviaion in inflaion from h arg * ( π π ) π* is h wighd avrag of h arg for h currn yar and h prvious yar; 7 and π is h Broad Naional Consumr Pric Indx (IPCA) accumulad in 12 monhs (official pric indx). I is xpcd ha h lack of accomplishmn of h inflaion arg implis an incras in h inrs ra and hus, wih som lag, an incras in h primary surplus for sabilizing h public db/gdp raio. (iii) Diffrnc bwn ral inrs ra and h growh conomic ra (R-G) h ral inrs ra is h Slic accumulad in h monh in annual rms dflad by IPCA; h conomic growh ra in h las 12 monhs is basd on GDP accumulad in h las 12 monhs (a consan prics and sasonally adjusd). Whn h ral inrs ra is grar han h conomic growh ra hr is a ngaiv impac on consumpion and invsmn. Morovr, high inrs ra provoks a ris in h public db. Hnc, i incrass h risk of fiscal imbalanc and hus primary surplus is ncssary for h sabilizaion. (iv) Public db/gdp raio (D) is h n public db (% GDP Fdral Govrnmn and CBB). An incras in h public db can b a rsul of an xpansionis fiscal policy, and hus cras a prssur of dmand which, in urn, implis a dparur of inflaion from h arg. (v) Inrs ra (IR) is h Slic accumulad in h monh in annual rms. I is h main insrumn for h cnral bank o rach h inflaion arg. Du o h rlvanc of h inrs ra in h indxaion of h Brazilian public db, a ris in h inrs ra for dcrasing dmand inflaion incrass h primary surplus for avoiding h risk of an unsusainabl public db pah. Thrfor, i is xpcd ha an incras in h inrs ra conribus o h convrgnc bwn inflaion and h arg. 6 S abl A.2 (appndix) wih dscripiv saisics of h sris. 7 For xampl, h arg in Jun of 22 is a rsul of (6*arg * arg 21). 1

11 (vi) Exchang ra (EX) Unid Sas dollar (sal) priod avrag. An incras in h xchang ra causs an incras in h pric of impord inpus and hus causs a ris in h inflaion ra which, in urn, dvias from h arg. Furhrmor, i is imporan o highligh ha in h priod from January of 2 o Dcmbr of 22 h rlvanc of h xchang ra in h indxaion of h public db was around 25%. (vii) Financial opnnss indx (FOI) i is a rsul of quaion (28). Th main ida is ha an incras in his indx is associad wih a dcras in h primary surplus for assuring sabiliy in h public db/gdp raio. A grar capial flow implis an incras in h cnral bank s commimn o achiv h inflaion arg. As a consqunc, a dcras in h inrs ra is possibl and hus a fall in h primary surplus for assuring consan public db/gdp raio. (viii) Capial conrol indx (CCI) his sris is mad basd on mhodology prsnd in h prvious scion. Th ida is similar o h cas of h FOI. A dcras in capial conrol works as a commimn chnology for h CBB o rach h inflaion arg Empirical vidnc Basd on h horical modl dvlopd in scion 3, an mpirical analysis for obsrving UFA in h Brazilian conomy is dividd in hr sps. A firs sp is h analysis concrning h ffc of h dviaion of inflaion from h arg on primary surplus. A scond sp prsns vidnc rgarding financial opnnss (FOI) and capial conrols (CCI) on h convrgnc bwn inflaion and h arg. A hird sp provids robusnss o h found rsuls by simaion of sysm of quaions usd in h prvious sps. Figur 5 shows h xisnc of a ngaiv corrlaion bwn dparur of inflaion from h arg and primary surplus. Morovr, in boh cass of FOI and CCI hr xiss a ngaiv corrlaion wih dviaion in inflaion from is arg. Thos obsrvaions ar in accordanc wih h horical viw. In ohr words, an incras in h capial flow improvs h cnral bank s commimn o rach h inflaion arg wih a lowr social cos, ha is, lss primary surplus which can b usd for ohr nds insad of paying db srvic. Making us of h variabls lisd in h prvious scion, simaions of h primary surplus (basd on quaion 24) and of h convrgnc bwn inflaion and is arg (basd on quaion 27) considr hr mpirical modls: 8 PS = δ + δ R G + δ π π + δ D + δ dummy + ε, ε ~ N(,σ 2 ); (29) 1( ) 1 2( *) π π = φ + φ IR + φ EX + φ D + φ FOI + φ dummy + φ dummy + ε ; (3) ( *) π π = τ + τ IR + τ EX + τ D + τ CCI + τ dummy + τ dummy + ε ; (31) ( *) whr dummy1 is h ffc causd by h subprim crisis (assums valu 1 for h priod from Ocobr of 28 o Spmbr of 29, and ohrwis); and dummy2 is h confidnc crisis in h Brazilian conomy du o h prsidnial lcion in 22 (assums valu 1 for h priod from July of 22 o Jun of 23, and ohrwis). 8 Th numbr of lags on ach variabl in h mpirical modls is in agrmn wih h im ha is ncssary, hrough is ransmission channls, for h variabls usd as rgrssors o caus an ffc on h dpndn variabl. 11

12 . Figur 5 Scar diagrams ( ) 16 Primary surplus Dviaion in inflaion from h arg Dviaion in inflaion from h arg Corrl.:-.16 Financial Opnnss Indx Corrl.: Dviaion in inflaion from h arg Capial Conrol Indx Corrl.: -.12 Esimaions of h quaions abov ar mad hrough ordinary las squars (OLS) and gnralizd mhod of momns (GMM). Th rason for h applicaion of h GMM is ha i prsns consisn simaors for h rgrssions vn whn problms as srial auocorrlaion, hroskdasiciy, or nonlinariy, which ar ypical in macroconomic im sris, ar obsrvd (Hansn, 1982). As a condiion o prdic h conmporanous variabls which ar unavailabl a im, h us of insrumns nds o b dad o h priod -1 or arlir (Wooldridg, 21). In his sns, bsids consan and lag of rgrssors, lag of oupu gap wr considrd as insrumns. 9 Bfor h us of im sris i is ncssary o chck if h sris hav uni roo. Whn h sris ar no saionary h possibiliy of h simaions bing spurious is high. Thrfor, wih h objciv of chcking h prsnc or no of uni roo in h sris h uni-roo s Augmnd Dicky-Fullr (ADF), Phillips-Prron (PP), and Kwiakowski-Phillips-Schmid-Shin (KPSS) wr xcud. Th rsul dnos ha h sris ar I(1) (s abl A.3 - appndix). Th rsul from h uni roo ss suggss ha h us of h firs diffrnc of h sris in h simaion of h quaions is corrc in ordr o avoid spurious rgrssion. Nvrhlss, long-rm 9 Oupu gap is h diffrnc bwn GDP accumulad in h las 12 monhs (mad availabl by h CBB wih monhly frquncy) and ponial GDP (obaind by Hodrick-Prsco filr). 12

13 informaion conaind in lvls of im sris will b los afr diffrncing (Chiarlla and Gao, 22). Thrfor, i is ncssary o chck if a linar combinaion among sris is saionary vn if individually sris ar nonsaionary. In ohr words, i is ncssary o vrify if h sris ar coingrad bcaus, in his cas, o us sris in lvl would imply rliabl saisics. Coingraion ss wr prformd aking ino accoun h hr quaions in h mpirical modl and h rsuls indica ha h sris ar coingrad in ach modl (s abls A.4 and A.5 appndix). As a consqunc, hr is a long-rm quilibrium rlaionship among h variabls undr analysis and hus h quaions can b simad wih h sris in lvl wihou h problm of spuriousnss. Tabl 1 prsns simaions basd on OLS and GMM mhods for quaion (29). I is obsrvd ha h saisical significanc and h sign of h cofficins ar in agrmn in boh mhods. Alhough h cofficin on h diffrnc bwn ral inrs ra and h growh conomic ra has a posiiv sign i is no saisically significan. In h sam mannr, h cofficin on h public db/gdp raio is posiiv wihou saisical significanc. I is imporan o no ha his obsrvaion is consisn wih h horical modl, whr h public db is a consan and hus i dos no hav a crucial rol in h xplanaion of h primary surplus. Furhrmor, as obsrvd in h horical modl, h main variabl for xplaining h primary surplus is h dviaion of inflaion from h arg. Tabl 1 Primary surplus (PS ) OLS and GMM simaions variabl OLS GMM Consan *** (.9422) [ ] (R - G) (.152) [.7132] (π - π*) ** (.197) [ ] D.381 (.29) [1.319] dummy1.9118*** (.3421) [2.6654] *** (.8119) [ ].166 (.12) [1.6329] -.288* (.157) [ ].5 (.262) [.195].7383** (.3457) [2.1356] Adj. R F-Sa P(F-Sa) (.) J-Sa P(J-Sa) (.2) S.E. rg No: Marginal significanc lvls: (***) dnos.1, (**) dnos.5, and (*) dnos.1. Sandard rrors in parnhss and -saisics in bracks. As xpcd, h dparur of inflaion from h arg mars in h bhavior of h primary surplus. Th cofficin on primary surplus is ngaiv and saisically significan. On inrpraion for his rsul is ha hr is no full cnral bank crdibiliy ovr his priod which, in urn, forcs h CBB o incras h inrs ra in ordr o rach h inflaion arg. Th consqunc of highr inrs ra is an incras in h public db srvic and a fall in h conomic aciviy. Hnc, for 13

14 avoiding h possibiliy of a fiscal imbalanc, highr primary surplus is ndd. Thrfor, h mpirical vidnc is consonan wih h horical viw and hus srnghns h ida ha i is ncssary o find mchanisms which mak h convrgnc of h inflaion o h arg as a way of miigaing UFA. Tabl 2 shows h simaions for quaions (3) and (31) using OLS and GMM mhods. Th rsuls in boh mhods ar in agrmn. As xpcd from h horical viw, h cofficin on h inrs ra is ngaiv and has saisical significanc. Hnc, an incras in h inrs ra provoks a convrgnc bwn inflaion and is arg. In rgard o h cofficin on h xchang ra, i is also compaibl wih horical prdicions. Th fac ha i is posiiv and saisically significan indicas ha h xchang ra channl is no ngligibl in h Brazilian conomy. Th rlvanc of h fiscal balanc for h succss of h inflaion arging is obsrvd wih h cofficin on h public db. Th posiiv sign of h cofficin and is saisical significanc mak clar ha incrass in h public db/gdp raio wrck h monary sysm. Tabl 2 Dviaion in inflaion from h arg (π - π*) OLS and GMM simaions variabl OLS OLS GMM GMM Consan (6.64) [ ] IR ** (.1413) [ ] EX ** (.831) [2.175] D ** (.1873) [2.1492] FOI *** (4.3823) [ ] (3.1533) [1.3689] *** (.61) [ ].2223*** (.54) [4.1144].335*** (.897) [3.3824] CCI *** (.358) [ ] dummy *** (1.4938) [2.7485] dummy ** (.7675) [2.3932] *** (.678) [5.9149] *** (.6848) [3.3358] (4.4835) [-1.46] *** (.13) [ ].1876** (.917) [2.457].4139** (.182) [2.2967] *** (4.612) [-3.91] * (2.2256) [1.7931] * (1.2439) (6.5654) [1.3628] *** (.128) [ ].2185** (.981) [2.2271].272** (.1332) [2.419] *** (.593) [ ] 5.143** (2.419) [2.5175] ** (1.5322) [2.384] [1.7925] Adj. R F-Sa P(F-Sa) (.) (.) J-Sa P(J-Sa) (.86) (.45) Insrumn rank No: Marginal significanc lvls: (***) dnos.1, (**) dnos.5, and (*) dnos.1. Sandard rrors in parnhss and -saisics in bracks. On imporan rsul from h simaions is h fac ha h cofficins on boh indics FOI and CCI ar ngaiv and saisically significan. Thrfor, h horical argumn ha dcrass in capial conrols and incrass in capial flow work as a commimn chnology for h cnral bank

15 focusing on h inflaion arg is rlvan. In ohr words, an incras in h opnnss conribus o rducing h divrgnc bwn inflaion and an inflaion arg. As a consqunc, h possibiliy of UFA undr his nvironmn dcrass. A mannr of validaing h quaions and cofficins prviously achivd is h simaion hrough sysm of quaions (s Hallsn, 1999). For raing possibl problms of ndogniy (in paricular, in h rlaion bwn primary surplus and dviaion in inflaion from h arg), h us of sysm of quaions which applis GMM is adqua for simaing non-biasd cofficins. Thrfor, basd on quaions 29 o 31, wo sysms of quaions ar considrd: (32) Sysm 1: (33) Sysm 2: PS = a + a1( R G) 1 + a2( π π*) 3 + a3d + a4dummy1 + ε ( π π*) = b + b1 IR 9 + b2ex 3 + b3d 6 + b4 FOI 1 + b5dummy1 + b6dummy 2 + ε PS = a5 + a6( R G) 1 + a7( π π*) 3 + a8d + a9dummy1 + ε ( π π*) = b7 + b8 IR 9 + b9ex 3 + b1 D 6 + b11cci 1 + b12 dummy1 + b13dummy 2 + ε Tabl 3 PS and (π - π*) - GMM sysm Sysm 1 Sysm 2 Variabl PS Variabl (π - π*) Variabl PS Variabl (π - π*) Consan *** Consan *** Consan *** Consan * (.7677) (3.2466) (.7345) (4.6836) [ ] [ ] [ ] [1.6746] (R - G) ** IR *** (R - G) ** IR *** (.8) (.115) (.82) (.798) [2.1243] [-4.648] [2.185] [-4.937] (π - π*) ** EX ** (π - π*) *** EX * (.144) (.798) (.142) (.76) [ ] [2.364] [ ] [1.7516] D.65 D *** D.18 D *** (.246) (.144) (.235) (.171) [.2644] [4.4147] [.7658] [3.5766] dummy1.7228** FOI *** dummy1.8179** CCI *** (.3311) (3.6956) (.3148) (.479) [2.1833] [ ] [2.5976] [-5.453] dummy dummy *** (1.941) (1.6766) [1.145] [3.379] dummy *** dummy *** (1.799) (1.2455) [3.2797] [3.597] Adj. R 2.25 Adj. R 2.64 Adj. R 2.25 Adj. R 2.66 J-saisic J-saisic p >.5 p >.4 No: Marginal significanc lvls: (***) dnos.1, (**) dnos.5, (*) dnos.1. Sandard rrors in parnhss and -saisics in bracks. 15

16 Tabl 3 shows h simaions for boh sysms abov. 1 Th rsuls indica ha all cofficins ar in accordanc wih h horical viw and, wih h xcpion of h cofficin on public db in h cas whr h primary surplus is h dpndn variabl, ar saisically significan. Furhrmor, h cofficins in h sysms ar clos o hos obsrvd in h individual simaions. In addiion, h fac ha h simaion hrough h sysms considrably incrasd h accuracy of h cofficins in h modls (h sandard rrors ar smallr) canno b nglcd. Thrfor, onc again mpirical vidnc shows ha h opnnss is a usful ool for incrasing h convrgnc bwn inflaion and is arg and hus rducs h risk of UFA occurring. 5. Concluding rmarks Th horical modl dvlopd in his aricl shows ha grar capial mobiliy anuas h fiscal srngh o assur ha h cnral bank will rach h inflaion arg. Grar opnnss implis grar public confidnc rgarding cnral bank accounabiliy bcaus i dcrass h risk of an xpansionis monary policy wihou punishmn. Th ransmission channl for dcrasing h possibiliy of UFA in h conomy is hrough h convrgnc bwn inflaion and is arg causd by an incras in h opnnss, and hus rducs h ncssiy of incrasing primary surplus. Th rsuls obsrvd from h hr sps in h mpirical analysis for h Brazilian conomy ar in consonanc wih prdicions of h horical modl. I is imporan o highligh ha boh indics usd in h analysis as proxis for opnnss ar rlvan for rducing h dviaion in inflaion from h arg. Morovr, h failur of h CBB in h achivmn of h inflaion arg mars for xplaining incrass in primary surplus. Thrfor, hr xiss vidnc ha incrass in opnnss work as a commimn chnology which conribus o h succss of h inflaion arging and hus rducs h risk UFA occurs. 6. Rfrncs BADINGER H. (29) Globalizaion, h oupu-inflaion radoff and inflaion. Europan Economic Rviw, 53(8), BARRO, R.J.; GORDON D. (1983) Ruls, discrion and rpuaion in a modl of monary policy. Journal of Monary Economics, 12(1), BARTOLINI, L.; DRAZEN, A. (1997) Capial accoun libralizaion as a signal. Amrican Economic Rviw, 87(1), CALVO, G.A.; REINHART, C. (22) Far of floaing. Quarrly Journal of Economics, 117(2), CARDOSO, E.; GOLDFAJN, I. (1998) Capial flows o Brazil: h ndogniy of capial conrols. IMF Saff Paprs, 45(1), CHIARELLA, C.; GAO, S. (22) Typ I spurious rgrssion in conomrics. Working Papr Sris N. 114, School of Financ and Economics, Univrsiy of Tchnology Sydny. CHINN, M.D.; ITO, H. (22) Capial accoun libralizaion, insiuions and financial dvlopmn: cross counry vidnc. NBER Working Paprs, COOKE, D. (21) Opnnss and inflaion. Journal of Mony, Crdi and Banking, 42(2-3), p DANIELS, J.P.; VANHOOSE D.D. (29) Trad opnnss, capial mobiliy, and h sacrific raio. Opn Economis Rviw, 2(4), DORNBUSCH, R. (1998) Capial conrols: an ida whos im is pas. In: Knn, P. (d.), Should h IMF pursu capial accoun convribiliy? Princon Essays in Inrnaional Financ, 27. Princon Univrsiy Prss. FRANKEL, J.A. (1999) No singl currncy rgim is righ for all counris or a all ims. NBER 1 Insrumns and lags ar h sam as hos applid in h simaion of h individual quaions. 16

17 Working Paprs, FREEDMAN, C.; ÖTKER-ROBE, I. (21) Imporan lmns for inflaion arging for mrging conomis. IMF Working Paprs, 1/113. GRUBEN, W.; McLEOD, D. (21) Capial accoun libralizaion and disinflaion in h 199s. Fdral Rsrv Bank of Dallas, Cnr for Lain Amrican Economics Working Paprs, 11. GUPTA, A.S. (28) Dos capial accoun opnnss lowr inflaion? Inrnaional Economic Journal, 22(4), HALLSTEN, K. (1999). Bank loans and h ransmission mchanism of monary policy. Svrigs Riksbank Working Papr, N. 73. HANSEN, L. P. (1982) Larg sampl propris of gnralizd mhod of momns simaors. Economrica, 5(4), KING, M. (1995) Commnary: monary policy implicaions of grar fiscal disciplin. In: Budg dficis and db: issus and opions, Fdral Rsrv Bank of Kansas Ciy, KYDLAND, F.E.; PRESCOTT, E.C. (1977) Ruls rahr han discrion: h inconsisncy of opimal plans. Journal of Polical Economics, 85(3), LOUNGANI, P.; RAZIN, A.; YUEN, C-W. (21) Capial mobiliy and h oupu-inflaion radoff. Journal of Dvlopmn Economics, 64(1), OBSTFELD, M.; TAYLOR, A.M. (1998) Th gra dprssion as a warshd: inrnaional capial mobiliy ovr h long run. In: Bordo, M.; Goldin, C.; Whi, E. (ds), Th dfining momn: h gra dprssion and h Amrican conomy in h wnih cnury, Univrsiy of Chicago Prss, RODRIK, D. (1998) Who nds capial accoun convribiliy? In: Knn, P. (d.), Should h IMF pursu capial accoun convribiliy? Princon Essays in Inrnaional Financ, 27. Princon Univrsiy Prss, ROGOFF, K. (23) Globalizaion and global disinflaion. Fdral Rsrv Bank of Kansas Ciy Economic Rviw, 88(4), (1985) Th opimal dgr of commimn o an inrmdia monary arg. Quarrly Journal of Economics, 1(4), ROMER, D. (1993) Opnnss and inflaion: hory and vidnc. Quarly Journal of Economics, 18(4), SARGENT, T.J.; WALLACE, N. (1981) Som unplasan monaris arihmic. Fdral Rsrv Bank of Minnapolis Quarrly Rviw, 5, SPIEGEL, M.M. (29) Financial globalizaion and monary policy disciplin: a survy wih nw vidnc from financial rmonss. IMF Saff Paprs, 56(1), TYTELL, I.; WEI S.J. (24) Dos financial globalizaion induc br macroconomic policis? IMF Working Paprs, 4/84. WAGNER, H. (21) Implicaions of Globalizaion for Monary Policy. IMF Working Paprs, 1/184. WOOLDRIDGE, J.M. (21) Applicaions of Gnralizd Mhod of Momns Esimaion. Journal of Economic Prspcivs, 15(4),

18 Appndix Cod 2845 Capial ransfrs (crdi) 2846 Capial ransfrs (dbi) Tabl A.1 Balanc of Paymns - US$ (million) Capial accoun Financial accoun Dirc invsmn 8188 Brazilian dirc invsmn (crdi) 8189 Brazilian dirc invsmn (dbi) 8196 Forign dirc invsmn (crdi) 8197 Forign dirc invsmn (dbi) Porfolio invsmn 2874 Brazilian porfolio invsmn Equiy and db scuriis oal (dbi) 2876 Brazilian porfolio invsmn forign company quiy xcluding BDR (dbi) 2879 Brazilian porfolio invsmn - Equiy and db scuriis oal (crdi) 2881 Brazilian porfolio invsmn forign company quiy xcluding BDR (crdi) 8215 Forign porfolio invsmn (crdi) 8216 Forign porfolio invsmn (dbi) Drivaivs 292 Financial drivaivs asss (n) 293 Financial drivaivs liabiliis (n) Ohr invsmns 2912 Ohr Brazilian invsmns ohr long rm asss (n) 2913 Ohr Brazilian invsmns - ohr shor rm asss (n) 2914 Ohr forign invsmns oal (n) Sourc: Cnral Bank of Brazil. All sris wr unsasond by ARIMA-X12 procss. Tabl A.2 Dscripiv Saisics Variabls Man Mdian Maximum Minimum Sd.Dv. PS (π - π*) (R-G) D IR EX FOI CCI

19 Tabl A.3 Uni roo ss (ADF, PP, and KPSS) Sris ADF PP KPSS lag s cv=1% band s cv-1% band s cv=1% Ordr OS I(1) PS I() (π - π*) I(1) (π - π*) I() (R-G) I(1) (R-G) I() D I(1) D I() IR I(1) IR I() EX I(1) EX I() FOI I(1) FOI I() CCI I(1) CCI I() No: cv is h criical valu. Consan and linar rnd wr usd for sris. ADF h final choic of lag was mad basd on Schwarz cririon. PP spcral simaion mhod is Barl krnl and Nwy-Ws Bandwidh is usd. KPSS - spcral simaion mhod is Barl krnl and Andrws Bandwidh is usd. Tabl A.4 Numbr of Coingraing Rlaions by Modl Daa rnd: Non Non Linar Linar Quadraic No inrcp Inrcp Inrcp Inrcp Inrcp Ts yp: No rnd No rnd No rnd Trnd Trnd PS, (R-G), (π - π*), D (π - π*),ir, EX, D, FOI (π - π*), IR, EX, D, CCI Trac * * Rank or N. of CEs Trac * -.768* Rank or N. of CEs Trac * 1.362* Rank or N. of CEs No: Schwarz criria by Rank (rows) and modl (columns). Lag spcificaion for diffrncd ndognous is basd on Schwarz and Hanna-Quinn criria in a VAR modl. 19

20 PS, (R- G), (π - π*), D (π - π*),ir, EX, D, FOI (π - π*), IR, EX, D, CCI Tabl A.5 Johansn s Coingraion Ts Hypohsizd Criical Valu Eignvalu Trac Saisic No. of CE(s) (.5) Prob.** R = * R R R R = * R 1* R R R R = * R R R R No: (*) dnos rjcion of H a h 5% significanc lvl. (**) MacKinnon-Haug-Michlis (1999) p- valus. 2