Is Bad News About Inflation Good News for the Exchange Rate?

Richard Clarida

Columbia University

Daniel Waldman Columbia University

Presentation given at the 8th Jacques Polak Annual Research Conference Hosted by the International Monetary Fund Washington, DC─November 15-16, 2007 Please do not quote without the permission from the author(s). The views expressed in this presentation are those of the author(s) only, and the

presence of them, or of links to them, on the IMF website does not imply that the IMF, its Executive Board, or its management endorses or shares the views expressed in the presentation.

88TTHH JJAACCQQUUEESS PPOOLLAAKK AANNNNUUAALL RREESSEEAARRCCHH CCOONNFFEERREENNCCEE NNOOVVEEMMBBEERR 1155--1166,, 22000077

IS B

AD

NE

WS

AB

OU

T IN

FLA

TIO

N G

OO

D N

EW

S F

OR

TH

E E

XC

HA

NG

E R

ATE

?

And

If S

o, C

an T

hat T

ell U

s A

nyth

ing

Abo

ut th

e C

ondu

ct o

f Mon

etar

y P

olic

y?

by

Ric

hard

Cla

rida

and

Dan

iel W

aldm

anC

olum

bia

Uni

vers

ity

OU

TLIN

E O

F TA

LK

•A

mod

el, a

hea

dlin

e, a

nd a

cur

ious

resu

lt.

•It’

s al

l in

Dor

nbus

ch?

No.

•In

flatio

n, T

aylo

r rul

es a

nd e

xcha

nge

rate

s.•

Wha

t can

this

say

abo

ut m

onet

ary

polic

y?•

Eve

nt s

tudy

set

up.

•E

mpi

rical

resu

lts.

Opt

imal

Mon

etar

y P

olic

y in

the

Ope

n E

cono

my

–C

GG

JM

E M

odel

•Tw

o co

untri

es, e

ach

with

sta

gger

ed p

rice

setti

ng

and

faci

ng ‘c

ost p

ush’

shoc

ks th

at g

ener

ate

infla

tion

iner

tia•

Hom

e an

d fo

reig

n co

untri

es p

rodu

cing

di

ffere

ntia

ted

trade

d go

ods

–te

rms

of tr

ade

a ke

y re

lativ

e pr

ice

•In

tern

atio

nal s

pillo

vers

via

mar

gina

l cos

t/opt

imal

la

bor s

uppl

y ch

anne

l•

Follo

w W

oodf

ord

and

deriv

e th

e ce

ntra

l ban

k w

elfa

re fu

nctio

n fro

m ta

ste,

tech

nolo

gy, a

nd

mar

ket c

lear

ing

subj

ect t

o th

e C

alvo

pric

ing

cons

train

t

IMP

LIC

ATI

ON

S•O

ptim

al m

onet

ary

polic

y in

eac

h op

en e

cono

my

is a

Tay

lor R

ule

i = rr

+ Eπ

+ b

(π–π

*)

•Und

er o

ptim

al p

olic

y, T

aylo

r Rul

e is

a fu

nctio

n of

dee

p pa

ram

eter

s

b = σ

+ (1

–σ)γξ

(1 –ρ)

> 0

•O

ptim

al p

olic

y fe

atur

es a

flex

ible

exc

hang

e ra

te, b

ut th

e ex

chan

ge

rate

itse

lf do

es n

ot e

nter

the

reac

tion

func

tion

•O

penn

ess

has

its e

ffect

s th

roug

h th

e ne

utra

l rea

l int

eres

t rat

e an

d th

e sl

ope

of th

e fo

rwar

d lo

okin

g Ta

ylor

Rul

e.

•Th

e no

min

al e

xcha

nge

rate

und

er o

ptim

al p

olic

y ha

s a

unit

root

as

does

the

dom

estic

pric

e le

vel a

nd th

ey a

re c

oint

egra

ted.

A C

UR

IOU

S R

ES

ULT

•C

GG

wor

k ou

t the

sym

met

ric,

two

coun

try N

ash

equi

libriu

m u

nder

cen

tral b

ank

disc

retio

n •

In th

is e

quili

briu

m, b

ad n

ews

abou

t inf

latio

n is

go

od n

ews

for t

he e

xcha

nge

rate

.•

That

is, a

Phi

llips

cur

ve s

hock

that

pus

hes

upac

tual

(and

exp

ecte

d) in

flatio

ntri

gger

s an

ag

gres

sive

rise

in n

omin

al a

nd re

al in

tere

st ra

tes

that

act

ually

cau

ses

the

nom

inal

exc

hang

era

te

to a

ppre

ciat

e.•

This

is s

o ev

en th

ough

in th

e lo

ng ru

n th

e no

min

al e

xcha

nge

rate

mus

t dep

reci

ate

in

resp

onse

to a

n in

flatio

n sh

ock.

TEN

SIO

N•

Usi

ng u

ncov

ered

inte

rest

par

ity a

nd lo

ng

run

purc

hasi

ng p

ower

par

ity w

e ha

ve

e =

-Σ n

=0,

Ti n+

Σn=

0,T π

n+

p –1

•In

the

long

run,

the

exch

ange

rate

mus

t de

prec

iate

in li

ne w

ith P

PP

. Alo

ng th

e ad

just

men

t pat

h it

is d

epre

ciat

ing.

•B

ut o

n im

pact

, it c

an a

ppre

ciat

e if

polic

y is

su

ffici

ently

tigh

t and

/or p

ersi

sten

t.

Dol

lar R

ises

as

U.S

. Con

sum

er In

flatio

n A

ccel

erat

es in

Feb

ruar

y

2005

-03-

23 0

8:49

(New

Yor

k)

By

Josh

ua K

rong

old

and

Mar

k Ta

nnen

baum

Mar

ch 2

3 (B

loom

berg

) --T

he d

olla

r ros

e ag

ains

t the

eur

o af

ter a

mea

sure

of i

nfla

tion

acce

lera

ted

last

mon

th, b

olst

erin

g ex

pect

atio

ns

the

Fede

ral R

eser

ve w

ill ra

ise

its b

ench

mar

k in

tere

st ra

te a

t a fa

ster

pac

e.

Not

‘Ove

rsho

otin

g’P

heno

men

on

•In

a D

ornb

usch

styl

e m

odel

with

a m

oney

gro

wth

targ

et,

will

get

ove

rsho

otin

g to

a m

oney

sup

ply

shoc

k th

at

push

es u

p in

flatio

n, b

ut th

e no

min

al e

xcha

nge

rate

de

prec

iate

sin

the

shor

t run

and

the

long

run.

•E

asy

to s

how

that

in a

Dor

nbus

chm

odel

with

a P

hilli

ps

curv

e sh

ock,

a s

hock

that

pus

hes

up in

flatio

nca

n ca

use

the

nom

inal

exc

hang

e ra

teto

dep

reci

ate

in th

e sh

ort r

un a

nd th

e lo

ng ru

n.•

Intu

itive

ly, i

n a

Dor

nbus

chm

odel

with

a m

oney

gro

wth

ta

rget

, the

long

run

PP

P a

ncho

r ten

ds to

mak

e th

e no

min

al e

xcha

nge

rate

and

the

pric

e le

vel m

ove

in th

e sa

me

dire

ctio

n w

heth

er o

r not

the

shoc

k is

to th

e m

oney

su

pply

or t

o th

e P

hilli

ps c

urve

.

Infla

tion

Sho

cks,

Tay

lor R

ules

, and

N

omin

al E

xcha

nge

Rat

es

•D

oes

the

insi

ght f

rom

CG

G (2

002)

app

ly m

ore

broa

dly

to in

flatio

n ta

rget

ing

in a

n op

en

econ

omy,

or i

s it

only

true

for o

ptim

al m

onet

ary

polic

y in

that

spe

cific

env

ironm

ent?

•Im

porta

nt to

allo

w fo

r end

ogen

ous

infla

tion

iner

tia, g

iven

the

PP

P a

ncho

r.•

Impo

rtant

to a

llow

for o

utpu

t gap

in T

aylo

r rul

e.•

Wha

t can

the

corr

elat

ion

betw

een

infla

tion

surp

rises

and

nom

inal

exc

hang

e ra

tes

tell

us

anyt

hing

abo

ut th

e co

nduc

t of m

onet

ary

polic

y?

Bas

ic Id

ea•

The

exch

ange

rate

is a

n as

set p

rice

with

refle

cts

pres

ent v

alue

of f

unda

men

tals

.•

Whe

n ce

ntra

l ban

k fo

llow

s a

Tayl

or ru

le, t

he

rele

vant

fund

amen

tals

are

out

put g

ap a

n in

flatio

n , s

ince

thes

e va

riabl

es d

rive

time

path

of

inte

rest

rate

s.•

The

effe

ct o

f a s

hock

on

exch

ange

rate

dep

ends

on

how

it in

fluen

ces

expe

ctat

ions

of c

urre

nt a

nd

futu

re m

onet

ary

polic

y.

Bas

ic Id

ea

•Th

e m

odel

, is

sim

ple

vers

ion

of S

vens

son

(200

0), a

nd h

as th

e pr

oper

ty th

at th

e eq

uilib

rium

dy

nam

ics

are

a fir

st o

rder

Mar

kov

proc

ess

in th

e st

ate

varia

bles

.•

How

ever

, the

par

amet

ers

of th

is p

roce

ss a

re

endo

geno

us fu

nctio

ns o

f the

mon

etar

y po

licy

rule

, the

Tay

lor r

ule

coef

ficie

nts.

•

An

equi

libriu

m if

it e

xist

s is

a fi

xed

poin

t in

the

spac

e of

exp

ecta

tions

ove

r the

sto

chas

tic

proc

ess

for i

nter

est r

ates

.•

Infla

tion

iner

tia is

end

ogen

ous

and

a fu

nctio

n of

m

onet

ary

polic

y.

The

Mod

el

•A

sm

all o

pen

econ

omy

that

take

s w

orld

inte

rest

ra

te a

nd lo

g w

orld

pric

e le

vel a

s gi

ven

and

cons

tant

and

equ

al to

zer

o. F

our e

quat

ions

. •

Agg

rega

te d

eman

d

y =

-r +

(e

-p)

r eq

uals

i –Eπ

+1th

e ex

ant

e re

al ra

tee

–p

is th

e lo

g re

al e

xcha

nge

rate

The

Mod

el

•A

ggre

gate

sup

ply

π=

π-1

+ y

+ ε

πis

dom

estic

infla

tion

and ε

is s

hock

. In

flatio

n in

ertia

.

•M

onet

ary

polic

y (a

s in

CG

G (1

998)

)

i = E

π+1

+ b(π

–π

*) +

ay

whe

n in

flatio

n ab

ove

targ

et o

r out

put a

bove

pot

entia

l, ce

ntra

l ban

k se

eks

to ra

ise

the

ex

ante

real

inte

rest

rate

. A

llow

for g

oal o

f sta

biliz

ing

outp

ut g

ap.

The

Mod

el

•In

tere

st P

arity

e –

p =

E (e

+1-

p+1)

–r

we

let q

= e

–p

and

note

e =

π+

q +

p-1

•V

ia in

tere

st p

arity

, the

log

leve

l of t

he re

al e

xcha

nge

rate

re

flect

s th

e en

tire

expe

cted

tim

e pa

th o

f mon

etar

y po

licy

q =

-E Σ

k=0,∞

r +k

Sol

ving

the

Mod

el•

Cou

ld d

o B

lanc

hard

Kah

n bu

t mor

e in

tuiti

on w

ith th

e ‘g

uess

and

ve

rify’

met

hod:

we

gues

s th

at in

the

real

inte

rest

rate

pro

cess

im

plie

d by

the

Tayl

or ru

le a

nd th

e ra

tiona

l exp

ecta

tions

equ

ilibr

ium

of

the

mod

el is

Mar

kov E

r +

j= d

j r

•If

this

gue

ss is

cor

rect

, the

re is

a s

impl

e re

latio

nshi

p be

twee

nr a

nd q

w

hich

for e

xam

ple

was

exp

loite

d by

Cam

pbel

l and

Cla

rida

(198

7)

q =

-r / (

1 –

d)

•W

e no

te th

at ∂

q/ ∂

r = -1

/ (1

–d)

refle

ctin

g th

e fa

ct th

at th

e le

vel o

f th

e re

al e

xcha

nge

rate

is th

e pr

esen

t val

ue o

f the

ent

ire fu

ture

time

path

of m

onet

ary

polic

y vi

a th

e Ta

ylor

rule

.

Sol

ving

the

Mod

el•

Und

er th

e gu

ess

that

E r

+ j=

d j r

we

can

expr

ess

the

proc

ess

for i

nfla

tion

as

π= π

-1-(

2 –

d) b

(π–π

*)/{(

1-d)

+ a

(2-d

)}

+ ε

•Th

e pr

oces

s fo

r the

real

inte

rest

rate

is

r =(1

–d)

b(π

–π

*)/{

(1-d

) + a

(2-d

)}

•Th

us r

will

be

stat

iona

ry fi

rst o

rder

Mar

kov

if π

is

stat

iona

ry fi

rst o

rder

Mar

kov

•Fr

om in

spec

tion,

we

see

that

πw

ill b

e st

atio

nary

firs

t ord

erM

arko

v if

ther

e is

a s

olut

ion

0 <

d* (b

, a) <

1 t

o th

efo

llow

ing

nonl

inea

r equ

atio

n

(1 +

(2 –

d*) b

/{(1-

d*) +

a(2

-d*)

}) =

1/d

*

•A

uni

que

ratio

nal e

xpec

tatio

ns e

quili

briu

m e

xist

s.

•Th

e pe

rsis

tenc

e of

inf

latio

n an

d th

us th

e in

tere

st ra

ted*

(b ,

a) is

end

ogen

ous

and

is d

ecre

asin

g in

b, t

he T

aylo

rru

le c

oeffi

cien

t on

infla

tion,

and

incr

easi

ng in

a, t

he T

aylo

rco

effic

ient

on

the

outp

ut g

ap.

Sol

ving

the

Mod

el

Exi

sten

ce o

f Rat

iona

l Exp

ecta

tions

Equ

ilibr

ium

Som

e Li

miti

ng C

ases

•A

s b →

0, d

(b ,

a) →

1

•A

s a →

∞, d

(b ,

a) →

1

•A

s b →

∞, d

(b ,

a) →

0

A S

hock

to In

flatio

n•

A te

mpo

rary

Phi

llips

cur

ve s

hock

ε

> 0

pus

hes

up

infla

tion

but b

y le

ss th

an th

e sh

ock.

Thi

s is

bec

ause

the

cent

ral b

ank

reac

ts b

y pu

shin

g up

the

nom

inal

and

the

ex a

nte

real

inte

rest

rate

. The

real

exc

hang

e ra

te

appr

ecia

tes

on im

pact

, ref

lect

ing

expe

ctat

ion

of a

pr

olon

ged

perio

d of

tigh

t mon

ey.

q =

-E Σ

k=0,∞

r +k

Wha

t abo

ut th

e no

min

al e

xcha

nge

rate

?

Exc

hang

e R

ate

Dyn

amic

s to

In

flatio

n S

hock

Res

ult:

For a

ny g

iven

a >

0,th

ere

exis

ts a

b(a

) su

ch th

at,

for

all b

> b

(a), ∂

e t /∂

ε t<

0.Th

at is

, if t

he c

entra

l ban

k re

spon

ds s

uffic

ient

ly a

ggre

ssiv

ely

to a

ris

e in

inf

latio

n,

the

nom

inal

exc

hang

e ra

te a

ppre

ciat

eson

im

pact

in

resp

onse

to a

n ad

vers

e in

flatio

n sh

ock.

Als

o b(

0) >

0.

Alo

ng th

e ad

just

men

t pat

h, th

e no

min

al e

xcha

nge

rate

is

depr

ecia

ting

and

the

nom

inal

inte

rest

rat

e is

fal

ling

(but

re

mai

ns a

bove

the

wor

ld in

tere

st ra

te).

A S

hock

to In

flatio

nb

> b(

a)

Sho

ck to

Infla

tion

b <

b(a)

Impu

lse

Res

pons

e to

Infla

tion

Sho

ck

Eve

nt S

tudy

•In

the

data

, wha

t is

the

sign

of t

he c

orre

latio

n be

twee

n in

flatio

n su

rpris

es a

nd e

xcha

nge

rate

ch

ange

s?•

Is it

sig

nific

ant?

•Is

it d

iffer

ent f

or in

flatio

n ta

rget

ers

and

non-

infla

tion

targ

eter

s?•

Is it

diff

eren

t for

hea

dlin

e in

flatio

n an

d co

re

infla

tion?

•D

o re

gim

e ch

ange

s ch

ange

the

sign

of t

he

corr

elat

ion?

Set

Up

•E

xpec

ted

infla

tion

from

Blo

ombe

rg.

•E

xcha

nge

rate

cha

nges

aro

und

time

of in

flatio

n an

noun

cem

ent f

rom

Mer

rill L

ynch

and

Ols

en.

•S

ampl

e is

mon

thly

from

Jul

y 20

01 to

Dec

embe

r 20

05.

Up

to 3

94 to

tal o

bser

vatio

ns fo

r 10

coun

tries

and

two

diffe

rent

mea

sure

s of

infla

tion,

he

adlin

e an

d co

re.

•Fo

r UK

bef

ore

inde

pend

ence

and

Nor

way

bef

ore

adop

tion

of in

flatio

n ta

rget

ing,

exp

ecte

d in

flatio

n fro

m M

MS

.

Tabl

e 1:

10-

Min

ute

Exc

hang

e R

ate

Ret

urns

AUD

-USD

NZD

-USD

EUR

-USD

Mea

n0.

00%

0.00

%0.

00%

Stan

dard

Dev

iatio

n0.

07%

0.09

%0.

05%

GB

P-U

SDU

SD-J

PYU

SD-C

ADM

ean

0.00

%0.

00%

0.00

%St

anda

rd D

evia

tion

0.05

%0.

05%

0.05

%

USD

-NO

KU

SD-S

EKU

SD-C

HF

Mea

n0.

00%

0.00

%0.

00%

Stan

dard

Dev

iatio

n0.

07%

0.07

%0.

06%

Tabl

e 2:

Infla

tion

Sur

pris

es

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Mea

n-0

.04

-0.0

4-0

.03

-0.0

10.

00-0

.01

-0.0

2-0

.02

Stan

dard

Dev

iatio

n0.

210.

230.

150.

170.

130.

150.

150.

14

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Mea

n-0

.07

-0.0

9-0

.09

-0.1

0-0

.03

-0.0

5-0

.03

-0.0

3St

anda

rd D

evia

tion

0.27

0.30

0.22

0.21

0.17

0.17

0.17

0.19

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Mea

n0.

030.

020.

020.

02-0

.01

0.04

0.00

0.00

Stan

dard

Dev

iatio

n0.

130.

120.

100.

080.

140.

180.

100.

12

Japa

nU

SH

eadl

ine

Cor

eH

eadl

ine

Cor

e

Hea

dlin

eC

ore

Hea

dlin

eC

ore

Nor

way

Swed

en

Hea

dlin

eC

ore

Hea

dlin

eC

ore

Can

ada

UK

New

Zea

land

Hea

dlin

eQ

oQYo

YM

oMYo

YQ

oQM

oMYo

YM

ean

-0.0

10.

000.

000.

00-0

.04

-0.0

3-0

.07

Stan

dard

Dev

iatio

n0.

180.

190.

090.

070.

160.

200.

23

Hea

dlin

eH

eadl

ine

Hea

dlin

eAu

stra

liaEu

ro A

rea

Switz

erla

nd

Tabl

e 3:

All

Cou

ntrie

s

MoM

YoY

MoM

YoY

Coe

ffici

ent

0.2

0.2

0.5

0.5

T- S

tatis

tic5.

96.

29.

79.

2R

-Squ

ared

0.08

0.09

0.27

0.25

# O

bser

vatio

ns39

438

725

725

9R

egre

ssio

n m

etho

d: s

tack

ed O

LS.

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Cou

ntrie

s: A

ustra

lia, C

anad

a, E

uro

area

, Jap

an, N

ew Z

eala

nd, N

orw

ay, S

wed

en, S

witz

erla

nd, U

K, a

nd U

S.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. S

ome

coun

tries

mis

sing

obs

erva

tions

.

Hea

dlin

eC

ore

Tabl

e 4a

: Ind

ivid

ual C

ount

ry R

esul

ts

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Coe

ffici

ent

0.07

0.04

0.5

0.2

0.3

0.2

0.3

0.3

T- S

tatis

tic O

LS1.

20.

85.

03.

32.

93.

13.

34.

0 W

hite

1.4

1.0

6.3

2.8

2.2

2.6

2.8

3.3

New

ey-W

est

1.2

0.9

6.7

2.7

1.9

2.1

2.3

2.7

R-S

quar

ed0.

020.

010.

470.

190.

140.

160.

180.

23#

Obs

erva

tions

5454

3050

5354

5054

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. N

umbe

r of o

bser

vatio

ns m

ay b

e le

ss th

an to

tal m

onth

s du

e to

mis

sing

obs

erva

tions

.W

hite

and

New

ey-W

est u

sed

to c

orre

ct fo

r pot

entia

l het

eros

ceda

stic

ity.

Can

ada

Cor

eH

eadl

ine

UK

Hea

dlin

eC

ore

Tabl

e 4b

: Ind

ivid

ual C

ount

ry R

esul

ts

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Coe

ffici

ent

0.5

0.6

1.3

1.3

0.3

0.2

0.2

0.2

T- S

tatis

tic O

LS2.

83.

57.

57.

73.

43.

33.

13.

1 W

hite

2.3

2.4

5.7

5.4

3.6

3.0

3.3

3.2

New

ey-W

est

2.0

2.1

6.6

5.7

3.4

3.1

2.9

2.9

R-S

quar

ed0.

190.

270.

650.

640.

230.

210.

210.

20#

Obs

erva

tions

3535

3235

4142

4042

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. N

umbe

r of o

bser

vatio

ns m

ay b

e le

ss th

an to

tal m

onth

s du

e to

mis

sing

obs

erva

tions

.W

hite

and

New

ey-W

est u

sed

to c

orre

ct fo

r pot

entia

l het

eros

ceda

stic

ity.

Swed

enH

eadl

ine

Cor

eN

orw

ayH

eadl

ine

Cor

e

Tabl

e 4c

: Ind

ivid

ual C

ount

ry R

esul

ts

New

Zea

land

Hea

dlin

eQ

oQYo

YM

oMYo

YQ

oQM

oMYo

YC

oeffi

cien

t0.

10.

10.

10.

10.

70.

10.

1T-

Sta

tistic

OLS

1.0

1.1

1.1

0.9

3.0

2.9

3.1

Whi

te1.

01.

11.

21.

03.

32.

73.

0 N

ewey

-Wes

t1.

11.

21.

11.

23.

22.

73.

4R

-Squ

ared

0.06

0.08

0.02

0.02

0.38

0.16

0.16

# O

bser

vatio

ns18

1754

5417

4853

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. N

umbe

r of o

bser

vatio

ns m

ay b

e le

ss th

an to

tal m

onth

s du

e to

mis

sing

obs

erva

tions

.W

hite

and

New

ey-W

est u

sed

to c

orre

ct fo

r pot

entia

l het

eros

ceda

stic

ity.

Hea

dlin

eAu

stra

liaH

eadl

ine

Switz

erla

ndH

eadl

ine

Euro

Are

a

Tabl

e 4d

: Ind

ivid

ual C

ount

ry R

esul

ts

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Coe

ffici

ent

0.07

0.1

0.07

0.07

-0.1

-0.2

0.1

0.2

T- S

tatis

tic O

LS1.

41.

81.

00.

7-0

.4-1

.10.

90.

7 W

hite

1.2

1.9

0.8

0.7

-0.4

-1.1

0.9

0.7

New

ey-W

est

1.3

1.6

0.7

0.7

-0.4

-1.2

0.9

0.8

R-S

quar

ed0.

040.

060.

020.

010.

000.

050.

010.

02#

Obs

erva

tions

5454

5152

5425

5425

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. N

umbe

r of o

bser

vatio

ns m

ay b

e le

ss th

an to

tal m

onth

s du

e to

mis

sing

obs

erva

tions

.W

hite

and

New

ey-W

est u

sed

to c

orre

ct fo

r pot

entia

l het

eros

ceda

stic

ity.

Japa

nH

eadl

ine

Cor

eC

ore

US

Hea

dlin

e

Tabl

e 5:

Infla

tion

Targ

eter

s ve

rsus

Non

-Infla

tion

Targ

eter

s

MoM

YoY

MoM

YoY

MoM

YoY

MoM

YoY

Coe

ffici

ent

0.3

0.2

0.6

0.5

0.01

-0.0

80.

10.

1T-

Sta

tistic

6.1

6.7

9.4

8.9

0.2

-0.8

1.3

1.1

R-S

quar

ed0.

110.

130.

370.

310.

000.

010.

020.

02#

Obs

erva

tions

286

310

152

182

108

7710

577

Reg

ress

ion

met

hod:

sta

cked

OLS

.P

erce

ntag

e ch

ange

in e

xcha

nge

rate

resu

lting

from

a o

ne p

erce

ntag

e po

int u

pwar

d su

rpris

e in

infla

tion.

Pos

itive

coe

ffici

ent i

ndic

ates

app

reci

atio

n of

dom

estic

cur

renc

y.In

flatio

n ta

rget

ers

incl

udes

: Aus

tralia

, Can

ada,

Eur

o ar

ea, N

ew Z

eala

nd, N

orw

ay, S

wed

en, S

witz

erla

nd, a

nd U

K.

Non

-infla

tion

targ

eter

s in

clud

es: J

apan

and

US

.D

ata:

Jul

y 20

01- D

ecem

ber 2

005.

Num

ber o

f obs

erva

tions

may

be

less

than

tota

l mon

ths

due

to m

issi

ng o

bser

vatio

ns.

Infla

tion

Targ

eter

sH

eadl

ine

Cor

eN

on-In

flatio

n Ta

rget

ers

Hea

dlin

eC

ore

Tabl

e 6:

Nor

way

and

UK

Pre

-Infla

tion

Targ

etin

g/In

depe

nden

ce Nor

way

Cor

eH

eadl

ine

MoM

YoY

YoY

YoY

Coe

ffici

ent

0.00

006

-0.0

005

-0.0

006

-0.0

008

T- S

tatis

tic O

LS0.

1-0

.5-0

.7-1

.0 W

hite

0.1

-0.7

-0.8

-1.6

New

ey-W

est

0.1

-1.1

-1.4

-1.6

R-S

quar

ed0.

000.

010.

010.

02#

Obs

erva

tions

4646

4640

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.Po

sitiv

e co

effic

ient

indi

cate

s ap

prec

iatio

n of

dom

estic

cur

renc

y.D

ates

: Nor

way

: Aug

ust 1

997-

Dec

embe

r 200

0. U

K: M

arch

199

3- D

ecem

ber 1

996.

Num

ber o

f obs

erva

tions

may

be

less

than

tota

l mon

ths

due

to m

issi

ng o

bser

vatio

ns.

UK

Hea

dlin

e

Posi

tive

Neg

ativ

ePo

sitiv

eN

egat

ive

Posi

tive

Neg

ativ

ePo

sitiv

eN

egat

ive

Coe

ffici

ent

0.1

0.3

0.1

0.3

0.4

0.6

0.3

0.6

T- S

tatis

tic2.

45.

12.

55.

44.

97.

14.

17.

2#

Obs

erva

tions

126

164

113

169

8098

8310

2R

egre

ssio

n m

etho

d: s

tack

ed O

LS.

Per

cent

age

chan

ge in

exc

hang

e ra

te re

sulti

ng fr

om a

one

per

cent

age

poin

t upw

ard

surp

rise

in in

flatio

n.P

ositi

ve c

oeffi

cien

t ind

icat

es a

ppre

ciat

ion

of d

omes

tic c

urre

ncy.

Cou

ntrie

s: A

ustra

lia, C

anad

a, E

uro

area

, Jap

an, N

ew Z

eala

nd, N

orw

ay, S

wed

en, S

witz

erla

nd, U

K, a

nd U

S.

Dat

a: J

uly

2001

- Dec

embe

r 200

5. N

umbe

r of o

bser

vatio

ns m

ay b

e le

ss th

an to

tal m

onth

s du

e to

mis

sing

obs

erva

tions

.P

ositi

ve in

dica

tes

infla

tion

high

er th

an e

xpec

ted

- bad

new

s.N

egat

ive

indi

cate

s in

flatio

n lo

wer

than

exp

ecte

d - g

ood

new

s.

MoM

YoY

MoM

YoY

Hea

dlin

eC

ore

Tabl

e 7:

Goo

d N

ews

vers

us B

ad N

ews