Testing asymmetries in Central Bank preferences in a small open economy: A study for Brazil

Abstract

Abstract In this paper, we extend Surico's (2007a) model to an open economy and test if the Brazilian Central Bank's loss function is asymmetric with regard to positive and negative deviations of the output gap and of the inflation rate from its target. Furthermore, we use tests for structural breaks to investigate changes in the conduct of policy and monetary authority's preferences. The results revealed that the Central Bank reacted more strongly to deviations of inflation from the target and the output gap after 2003. With regard to the monetary authority's preferences, estimates indicate only an asymmetric preference over an above-target inflation rate until mid-2003. After this period, the evidence obtained by estimating the reaction function with inflation expectations showed that the Central Bank has been more averse to positive deviations of inflation from its target.