Regime-dependent price puzzle in the Brazilian economy: evidence from VAR and FAVAR approaches

Giuliano Queiroz Ferreira () and Leonardo Bornacki Mattos ()
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Giuliano Queiroz Ferreira: University of SãoPaulo
Leonardo Bornacki Mattos: Federal University of Viçosa

SN Business & Economics, 2022, vol. 2, issue 9, 1-28

Abstract: Abstract The price puzzle occurs when a contractionary monetary policy innovation is followed by an increase, rather than a decrease, in the price level, which contradicts the conventional economic theory. The paper helps explain the connection between economic regimes and the response of prices to monetary policy shocks. We provide empirical evidence that the price puzzle is regime dependent in the Brazilian economy. Prices respond differently to a tightening of monetary policy at intervals of activity slowdown when compared to periods of economic expansion. The paper examines the effectiveness of the short-term nominal interest rate used to control inflation in the Brazilian economy. More precisely, we investigate whether the price puzzle, found in previous empirical studies, consists of model misspecification or a feature of the economy. To analyze the anomaly, we estimate the effect of monetary policy innovations on the economy using the standard VAR and FAVAR approaches spanning the period from July 2003 to June 2018. The results suggest that the price puzzle stands out as a feature of the economy only at intervals of activity slowdown. Thus, the Brazilian Central Bank should only use the policy rate to control inflation in moments of economic “boom” when we do not observe the perverse reaction of prices.

Keywords: Price puzzle; Monetary policy; Inflation rate; Economic regimes; Credit channel (search for similar items in EconPapers)
JEL-codes: E52 E58 E59 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s43546-022-00295-2

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