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2009 AEC- Monetary Policy Design when Consumption Prices are Subsidized The Case of Tunisia Mohamed Safouane Ben Aijssa¤ Nooman Rebeiy

10-Nov-2009

Several theoretical studies suggest that price inflation targeting is the right design for a monetary policy. Experiences of several inflation targeters in the 1990s motivate this result. In particular, those countries attained substantial decline in output, inflation and interest rate fluctuations. Many other countries are adopting this monetary regime including emerging markets and developing countries despite their different historical experiences and economic environment. In fact, those countries face different market imperfections and government interventionism in setting prices or quantities in some markets. This paper uses structural general-equilibrium approach with price rigidity to test the premise that inflation targeting is welfare improving taking into consideration an environment where government subsidizes a share of private consumption expenditures. Our approach consists in estimating a dynamic stochastic general-equilibrium model for Tunisia with Bayesian techniques. Then, a second order approximation of the model is applied to compare several Taylor Rule’s specifications based on different definitions of inflation rates (CPI and sectoral price indexes). Results show that strict CPI inflation targeting would worsen household’s welfare compared to the historical monetary rule. Furthermore, CPI inflation targeting can be easily overcome by sectoral inflation targeting or by output gap stabilization.

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