Monetary Policy in Colombia

Client: Central Bank of Colombia

Authors/Consultants: Arenas F, Hamann F

The Pontificia Universidad Javeriana (Columbia) and the Central Bank of Colombia cooperated in an effort to recast the bank’s MTM (Mechanism of Transmission Model) into a system dynamics model. This joint effort represents an application of system dynamics to macroeconomics.

There are three options for a central bank to achieve its monetary goals: controlling the base money growth, inflation targeting and implementing a fixed exchange rate regime. The monetary policy of the Central Bank of Colombia (Banco de la República) is directed at keeping inflation to a minimum. This strategy consists, basically, of controlling the interest rate in such a way, that the inflation forecast be aligned with the inflation target.

After simulating the system dynamics model for shocks to the inflation target and monetary policy, the pattern of performance of the variables in the SD model, was quite similar to that of the MTM. The only difference occurred in a downward jump of depreciation in the first year of the simulation. This performance makes a noticeable difference between the SD and MTM results when shocks are applied to food supply, nominal depreciation, and risk premium. In spite of the differences, the TREND function seems to be an appropriate way to capture adaptive expectations in this model.

The Central Bank of Colombia concluded that the system dynamics model is similar the MTM model in important respects. The bank continues to support efforts to build a comprehensive system dynamics model supporting its monetary policies.

More information on this case can be found via Fernando Arenas and Franz Hamann (2005) An Adaptive Expectations Approach to the Mechanisms of Transmission Model of the Central Bank of Colombia. System Dynamics Society Conference.

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