Estimating New Financial Conditions Indexes for the Peruvian Economy

This paper introduces novel monthly indicators to assess financial conditions in Peru’s partially dollarized economy. Recognizing the unique monetary landscape, we develop separate measures for domestic (sol) and foreign currency (USD) financial conditions. These indicators are derived using principal component analysis (PCA) on a set of currency-specific relevant variables. We further employ a Bayesian Vector Autoregressive (VAR) model identified through zero and sign restrictions for structural analysis. Our findings reveal that the estimated indexes respond consistently to macroeconomic and financial shocks. The historical decomposition demonstrates that sol-denominated financial conditions are influenced by: i) Monetary policy actions, ii) Macroeconomic factors (aggregate supply and demand), iii) Inflation expectations and iv) Domestic currency liquidity demand. Similarly, USD-denominated financial conditions are affected by macroeconomic factors, with significant additional contributions from: i) Exchange rate fluctuations, and ii) An exogenous idiosyncratic component linked to global financial conditions. This research provides valuable insights into the complex dynamics of financial conditions in dual-currency economies, offering policymakers and researchers a nuanced tool for economic analysis and decision-making in Peru and similar markets.