Transmission mechanisms and inflation
targeting: the case of Colombia’s desinflation
Javier Gómez, Juan Manuel Julio
Abstract
October 2000*
Colombia has been on a
steady disinflation path since the early 1990s. The paper presents a model of the
transmission mechanisms of monetary policy in Colombia, in order to examine this
disinflation. The model is used to describe the evolution of inflation in response to
shocks to the terms of trade, the risk premium, across different monetary policy rules;
and in particular, under different assumptions about the formation of inflation
expectations. We then illustrate the behaviour of the economy under a permanent shift to
the inflation target and quantify the sacrifice ratio under different kinds of formation
of inflation expectations. This helps us to judge to what extent the shift towards a more
forward-looking wage and price setting affects the disinflation process and its cost.
Finaly, we estimate the welfare gains from disinflation and provide a inflation forecast
for Colombia.
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Prepared for the CCBS (Bank of England) Workshop on
Transmission Mechanisms of Monetary Policy. jgomezpi@banrep.gov.co;
jjulioro@banrep.gov.co. This is a working
paper for discussion, the views expressed in this paper are those of the authors and not
necesarily those of the Banco de la República nor its Board of Directors. The authors
wish to thank Laurence Ball, Ron Smith, Miguel Urrutia, Hernando Vargas, and Adolfo Cobo
for comments, Rodrigo Avella for research asistance, and Lavan Mahadeva and Grabriel
Sterne for their valuable suggestions and for the organization of a most enjoyable
workshop. All remaining errors are ours.
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