The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England. We have benefited greatly from the comments and suggestions of Bill

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We estimate the output loss associated with deliberate disinflation – the sacrifice ratio – for six small open economies, through the simulation of estimated VAR models where the historical monetary policy has been identified. Compared to estimates of other studies, our estimated sacrifice ratios are quite low for Norway and Sweden, quite high for Canada and the Netherlands, and relatively precisely estimated. A low sacrifice ratio implies, ceteris paribus, that inflation can be stabilized within narrower bands for a given variability of output. Varying sacrifice ratios across inflation-targeting countries may suggest that the inflation-rate bandwidth should also vary.

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Please do not quote without permission The views expressed in this paper do not necessarily reflect those of the Bank of England. List of contents page Abstract 3

The views expressed are those of the authors and not necessarily those of the Bank of

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inflation with and without the output gap Some observers have worried that under or over-estimating the output gap may unnecessarily induce tightening or loosening of monetary conditions, causing real fluctuations. To investigate the relationship between the output gap and inflation, we examine models of inflation that do and do not use the output gap. The Phillips curve, which relates inflation to real activity, is regarded as the maintained theory of inflation. Models of inflation without the output gap include the equation of exchange of the quantity theory of money, the real interest rate gap, and two versions of the P * model. Since none of these economic models are either totally wrong nor complete, it makes sense to diversify across models rather than relying on one model exclusively. The forecasts derived from different stable models can be combined through averaging, which offsets biases and reduces the forecast error variance. Such model diversification spreads the risks of errors (i.e., insurance about bad outcomes that arise from the reliance on a single model) and provides greater robustness for policy. This paper examines ten different models of inflation and estimates sixty-seven different specifications, some of which outperform others. Some explanatory variables like money and the real interest rate gap seem to provide more information about future inflation than does estimates of output gap. 1

Reconciling the New Keynesian model with observed persistence The views expressed are those of the author and do not necessarily reflect the views of the Bank of Finland. This project arose from discussions with Juha Tarkka and Jouko Vilmunen. I am very grateful to Juha for his enthusiasm for the project, valuable discussions, and substantial input, which significantly improved the paper. I would also like to thank Jouko and Mika Kortelainen for their many quality suggestions and technical advice. Suomen Pankin keskustelualoitteita