Inflation-output trade-offs in an optimization-based econometric framework applied to an open economy: The case of Japan

Applying an optimization-based econometric framework to an open economy for the evaluation of monetary policy, this paper examines the dissolving of inflation-output trade-offs, or improving social welfare, through inflation targeting by using data for Japan. We simulate a counterfactual inflation targeting policy with a model following New Keynesian Open-economy Macroeconomics, by estimating the historical feedback rule and deep parameters, and identifying shock processes. The findings indicate that consumer price index inflation targeting with commitment improves social welfare when compared with the historical policy in Japan. It does so through stabilizing not only the producer price inflation rate, but also output.