From the “Great Inflation” to the “Great Moderation” in Peru: A Time Varying Structural Vector Autoregressions Analysis

Produced by: 
Banco Central del Perú
Available from: 
April 2016
Paper author(s): 
Paul Castillo
Jimena Montoya
Ricardo Quineche
Macroeconomics - Economic growth - Monetary Policy

Over the last 30 years, the Peruvian economy has shown a dramatic decrease in the volatility of its macroeconomic aggregates. Following Primiceri (2005), Benati (2008) and Galí and Gambetti (2009), a Bayesian structural vector autoregression with time-varying parameters and variance covariance matrix of the innovations is used to analyse the underlying causes of Peruvian "Great Moderation". The Peruvian economy is modelled using real GDP growth, inflation and the rate of growth of M1 (money base). Our main results show: (1) Monetary policy has contributed significantly to the "Great Moderation" by reducing the volatility of its non-systematic component and by changing its reaction function to demand and supply shocks; (2) Structural reforms also contributed to reduce the responsiveness of GDP and inflation to demand and supply shocks; (3) During the period of high volatility, supply and policy shocks were the most important determinants of macroeconomic instability.


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