Regional inflation dynamics and the inflation targeting framework in Peru

The monetary policy of the Central Reserve Bank of Peru (BCRP) has been based on an inflation-targeting framework for more than a decade, using inflation in Metropolitan Lima as an operational measure. An alternative indicator is national inflation, whose statistical quality and real-time availability have improved substantially in recent years. Given these alternative indicators, it is worth asking: What have been the implications for national inflation of monitoring inflation in Lima? Would monitoring national inflation significantly affect the functioning of monetary policy in Peru? To answer these questions, we estimate an error-correction model for regional inflation rates and investigate how inflationary shocks spread throughout the country. The model incorporates (i) aggregation constraints, whereby each regional inflation rate is affected by an aggregate of the inflation rates of neighboring regions, and (ii) long-run constraints that allow for the identification of a common trend in the system. The results indicate that an inflation shock in Lima is rapidly transmitted to inflation rates in the provinces and explains a large portion of their variability. Consequently, it is concluded that by monitoring inflation in Lima, the BCRP has contributed to national inflation stability. (Audio: Department of Economic Publications)