Inflation Persistence and Changes in the Monetary Regime: The Argentine Case

For many years, a prevalent stylized fact in the literature on inflation dynamics has been that inflation is a highly persistent process, sometimes close to a random walk. This feature of the inflation process has several important implications for monetary policy modeling and conducting. From the point of view of policy modeling, persistence is a feature of inflation closely related to the assumptions on price formation in which the standard models currently used for policy modeling are based. From a more practical perspective it is clear that having a good knowledge of how rapidly inflation approaches its equilibrium level is crucial for the effectiveness of policy actions. Recent empirical evidence has shed light on the close relationship between inflation persistence and monetary policy regime. These studies revealed the importance of evaluating the presence of breaks in the mean of inflation and considering a time varying mean, if necessary, to adequately measure persistence. They also provided evidence that changes in the mean of inflation appear to be related to regime shifts. The assumption of a constant mean is clearly not plausible for Argentina, a country that has experienced a period of high and persistent inflation during the 80´s, a hyperinflation episode by the end of this decade and a period of low inflation from then on. Inflation was very high during the 80´s, a period in which monetary policy was quite exogenously determined because of f iscal dominance. This high inflation period ended in a hyperinflation episode after which a currency board regime was adopted. Under this regime monetary policy was passive and the dynamics of inflation was, to a certain extent, exogenously driven. Inflation remained at very low levels during this period which ended with the abandonment of Convertibility in January 2002. Following the sharp devaluation of the peso, which led to a dramatic change in relative prices, inflation raised, reaching a peak in April 2002. It then returned to lower levels, although a bit higher than those of Convertibility. The historical behavior of inflation in Argentina suggests that modeling inflation dynamics is not an easy task. Structural breaks make it quite difficult to obtain a unique model for a long period of time. We study the issue of inflation persistence in Argentina for the period 1980-2007 from two perspectives: univariate time-series and disaggregate frequency-domain analysis of the Consumer Price Index (CPI) inflation. From the first viewpoint the appropriateness of considering a time-varying mean is evaluated by comparing measures of persistence for both a constant and a time-varying mean. The second approach focuses on a spectral decomposition of CPI sub-indexes´ monthly price changes during the last two monetary regimes in Argentina (Convertibility and post-Convertibility regimes) in order to get a deeper insight into the differences between the dynamic features of both inflation processes. We are able to identify significant changes in mean and persistence of inflation in Argentina during the period 1980-2007. Breaks in mean inflation are clearly related to regime shifts: the hyperinflation period in 1989, when the whole sample is considered; and the abandonment of the Convertibility regime in 2002, when we analyze the low inflation period separately. Given the presence of breaks we differentiate inflation with respect to a time varying mean to measure persistence. Only by subtracting a time varying mean to inflation the estimated persistence decreases significantly. We find that inflation was highly persistent during the high inflation period, but strongly declined when inflation lowered after the adoption of Convertibility regime in 1991. Then, it increased slightly after the adoption of a managed float in 2002. Regarding the comparison between inflation dynamics during the Convertibility and post-Convertibility regimes, frequency-domain analysis provided us with some interesting insights. Overall volatility in prices is significantly higher in the recent period, though the contribution of high-frequency (temporary and seasonal) movements to this volatility was relatively more important during the Convertibility regime. That said, persistence is key to explain price dynamics during the post-Convertibility regime, while that was not necessarily the case in the previous period. Summing up, we find that, in line with the empirical evidence, changes in persistence in Argentina are related to monetary regime changes.