Financial Stress and macroeconomic fluctuations in Peru.

The degree of financial stress can have implications for the dynamic of macroeconomic variables. This paper develops a financial stress index (FSI) for the Peruvian economy, using Principal Component Analysis (PCA) over a broad set of financial variables covering the banking sector, capital markets, money and foreign exchange markets. After estimating the FSI, to assess the impact from financial stress to the real sector variables, an impulse response analysis is performed through Local Projection developed by Jordà (2005), in its nonlinear extension by Gorodnichenko and Auerbach (2013) since financial stress impact on macroeconomic dynamics is non-linear. Results show that during periods of stable financial markets, macroeconomics dynamics are consistent with the Newkeynesian framework where monetary policy has a stabilizing role after a demand shock hits the economy. However, during financial stress episodes, the effectiveness of monetary policy is reduced, given the same shock.