External Shocks and Economic Fluctuations in Peru: Empirical Evidence using Mixture Innovation TVP-VAR-SV Models

Abstract

We employ a family of mixture innovation, time-varying parameter VAR models with stochastic volatility (TVP-VAR-SV) to analyze the impact of external shocks on Peru’s GDP growth, inflation, and interest rate from 1998Q1 to 2019Q4. Our key findings are as follows: (i) the model best fitting the data features time-varying parameters and variances with a certain likelihood; (ii) impulse-response functions reveal that a 1% increase in the growth rate of Peru’s major trading partners (China and the U.S.) leads to a domestic GDP growth expansion of 0.65% and 0.21%, respectively; (iii) the forecast error variance decomposition shows that external shocks account for 65% of the long-term variability in output, 65% in inflation, and 67% in the interest rate; (iv) historical decomposition indicates that external shocks account for 50% of domestic GDP growth, particularly from 2002 onward. Lastly, we validate the results obtained in the primary specification through four robustness exercises