O Senay, A Sutherland Joumal of International Economics 117(2019)196-208 able 8 Parameter variations. Welfare difference St Dev rER gap? 0 57s76 1250259 00033 Dev(optimal policy)StDev(inflation targeting). Table 9 Alternative values forn 00001 0001 olicy rule 0.129 0.004 0.621 0999 0998 0996 Welfare difference 0.1481 00304 00156 00038 00024 Portfolio(optimal) (inf tar) PPI Inflation utput gap 0349 RER gap 0.64 (inf tar) 724 Note: Each column shows the optimal policy rule coefficients, the welfare difference between optimal policy and inflation targeting. standard deviations and equilibrium portfolios for imal policy and inflation targeting. Welfare is measured in terms of the equivalent percentage of steady-state consumption Standard deviations are measured in percentages portfolio holdings are measured relative to steady state GDP. five shocks simultaneously, while it may or may not be a good hedge can be thought of as a measure of openness, where a value of y close gainst taste shocks. A further intriguing question therefore arises: to 0.5 implies a more open economy and a value of y close to unity im- are there other forms of shock which give rise to a hedging conflict of plies a less open economy. The results in Table 8 show that the welfare the form generated by taste shocks? We leave this question to further gains from optimal policy are marginally larger for more open econo- research. mies. It also appears that the stabilising effect of optimal policy on the real exchange rate gap is also more significant for more open The second set of results in Table 8 show the effects of varying the We now briefly consider the effects of varying a number of key degree of risk aversion, p. The results show that the wellare gains forop- neir bench the effects of varying the share of home and foreign goods in the con- effect on the real exchange rate gap also increases as risk aversion Imption basket, y, the degree of risk aversion, p, and the elasticity of The third set of results in Table s show the effects of varving theela values for 0 and for each parameter combination we show the welfar ticity of labour supply, 1/. The results show that the welfare gains from difference between optimal policy and inflation targeting and also the optimal policy are higher when labour supply is more elastic.The labour ratio of the standard deviation of the real exchange rate gap for optimal supply elasticity has only a minor effect on the stabilising effect of opti- policy relative to the standard deviation for inflation targeting. mal policy on the real exchange rate gap. The first set of results in Table 8 shows the effects of varying the Table 9 shows the effect of varying the parameter n in the endoge- share of home and foreign goods in the consumption basket, y This nous discount factor(for the case where 0=1.5). This table shows that, in contrast to the effects of the parameters shown in table 8, vary- ngn has a potentially very significant effect on the size of welfare gains. gainst thor five shocks, it also appears that the available assets are such a good A very small value of n implies that the discount factor adjusts very se five shocks that there is in any case no significant trade-off between gradually to changes in aggregate consumption. This in turn impliesfive shocks simultaneously, while it may or may not be a good hedge against taste shocks.23 A further intriguing question therefore arises: are there other forms of shock which give rise to a hedging conflict of the form generated by taste shocks? We leave this question to further research. 6.4. Parameter variations We now briefly consider the effects of varying a number of key parameters away from their benchmark values. Table 8 summarises the effects of varying the share of home and foreign goods in the con￾sumption basket, γ, the degree of risk aversion, ρ, and the elasticity of labour supply, 1/ϕ. For each parameter variation we show a range of values for θ and for each parameter combination we show the welfare difference between optimal policy and inflation targeting and also the ratio of the standard deviation of the real exchange rate gap for optimal policy relative to the standard deviation for inflation targeting. The first set of results in Table 8 shows the effects of varying the share of home and foreign goods in the consumption basket, γ. This can be thought of as a measure of openness, where a value of γ close to 0.5 implies a more open economy and a value of γ close to unity im￾plies a less open economy. The results in Table 8 show that the welfare gains from optimal policy are marginally larger for more open econo￾mies. It also appears that the stabilising effect of optimal policy on the real exchange rate gap is also more significant for more open economies. The second set of results in Table 8 show the effects of varying the degree of risk aversion, ρ. The results show that the welfare gains for op￾timal policy appear to increase as risk aversion increases. The stabilising effect on the real exchange rate gap also increases as risk aversion increases. The third set of results in Table 8 show the effects of varying the elas￾ticity of labour supply, 1/ϕ. The results show that the welfare gains from optimal policy are higher when labour supply is more elastic. The labour supply elasticity has only a minor effect on the stabilising effect of opti￾mal policy on the real exchange rate gap. Table 9 shows the effect of varying the parameter η in the endoge￾nous discount factor (for the case where θ = 1.5). This table shows that, in contrast to the effects of the parameters shown in Table 8, vary￾ing η has a potentially very significant effect on the size of welfare gains. A very small value of η implies that the discount factor adjusts very gradually to changes in aggregate consumption. This in turn implies Table 9 Alternative values for η. η 0.0001 0.0005 0.001 0.005 0.01 Policy rule δY 0.129 0.129 0.129 0.129 0.129 δτ 0.004 0.004 0.002 −0.007 −0.012 δD −20.2 −5.72 −3.37 −1.02 −0.621 δℒ 0000 0 δπ 0.999 0.999 0.999 0.998 0.996 Welfare difference 0.1481 0.0304 0.0156 0.0038 0.0024 Portfolio (optimal) ðbondsÞ ðequitiesÞ 17:9 19:1 19:1 16:3 20:0 14:3 23:8 5:8 27:2 −2:0 (inf tar) ðbondsÞ ðequitiesÞ 19:9 0:4 20:0 0:4 20:1 0:4 21:1 0:3 22:0 0:3 PPI Inflation (optimal) 0.0049 0.0053 0.0057 0.0074 0.0087 Output gap (optimal) 0.023 0.035 0.046 0.095 0.131 (inf tar) 1.064 0.483 0.349 0.196 0.188 RER gap (optimal) 0.10 0.21 0.29 0.64 0.88 (inf tar) 7.24 3.28 2.37 1.32 1.27 Note: Each column shows the optimal policy rule coefficients, the welfare difference between optimal policy and inflation targeting, standard deviations and equilibrium portfolios for optimal policy and inflation targeting. Welfare is measured in terms of the equivalent percentage of steady-state consumption. Standard deviations are measured in percentages. Portfolio holdings are measured relative to steady state GDP. Table 8 Parameter variations. Welfare difference1 St Dev RER gap2 θ 0.5 1.5 0.5 1.5 γ 0.6 0.0040 0.0045 0.28 0.24 0.7 0.0037 0.0044 0.41 0.28 0.8 0.0033 0.0041 0.55 0.37 0.9 0.0029 0.0037 0.67 0.53 ρ 0.5 0.0025 0.0037 0.84 0.75 1 0.0026 0.0036 0.77 0.64 2 0.0030 0.0038 0.64 0.48 5 0.0042 0.0052 0.40 0.26 ϕ 0.5 0.0033 0.0050 0.61 0.50 2 0.0030 0.0038 0.64 0.48 5 0.0028 0.0033 0.68 0.47 9 0.0027 0.0032 0.69 0.47 1 Welfare difference between optimal and inflation targeting. 2 StDev(optimal policy)/StDev(inflation targeting). 23 Indeed, once taste shocks are excluded, not only is there no significant hedging conflict between the other five shocks, it also appears that the available assets are such a good hedge against those five shocks that there is in any case no significant trade-off between inflation targeting and risk sharing. O. Senay, A. Sutherland / Journal of International Economics 117 (2019) 196–208 207