Abstract
The Bolivian inflation process is analyzed utilizing a time-varying univariate and multivariate Markov-switching model (TMS). With monthly data and, beginning in the late 1930s, inflation is accurately described by a univariate TMS. The intercept for the high-inflation regime is significantly higher than for the low-inflation regime and the actual inflation rate mirrors the smoothing probabilities of the Markov process. Additionally, the predicted duration of each regime closely fits the periods when the country experienced low and inordinate high inflation rates. From a long-run perspective and utilizing a multivariate TMS, the results generally fall in line with what the quantity theory of money predicts. In the high-inflation regime, money growth increases inflation (almost) one-for-one, as classical economics contends. From a short-run perspective and in the high-inflation regime, inflation is almost exclusively explained by a negative output gap. In the low-inflation regime, lagged inflation is the most important determinant of inflation, in line with price stickiness expectations. Partitioning the sources of inflation demonstrate that, from a long-run perspective and in the high inflation regime, differences in inflation are mostly explained by GDP growth; in the low-inflation regime, money growth and velocity growth are the principal factors explaining the variance of inflation. From a short-run perspective, the output gap explains almost all regression variance in the high-inflation regime, and past inflation does the same during times of low inflation, though in both cases the R2 is low which precludes making definite statements about the sources of variability in inflation.
Highlights
Models of inflation have typically specified the inflation process as a function of a wide set of macroeconomic and policy-related variables, often involving complicated dynamic structures
1985) where yearly inflation rates were above 1000 percent, and there were 38 years where inflation rates were below 10 percent
Utilizing a time-varying univariate and multivariate Markov-switching model (TMS), the inflation process in Bolivia is described starting in the late 1930s
Summary
Models of inflation have typically specified the inflation process as a function of a wide set of macroeconomic and policy-related variables, often involving complicated dynamic structures. The novelty of this work lies in the utilization of Markov-switching models to determine the causes of inflation in the short and long run in a country accustomed to great price volatility. To my knowledge, this is the first time that inflation in Bolivia is analyzed using a time-varying, Markov-switching model encompassing the period 1937–2020 In countries, such as Bolivia, that have experienced hyperinflation more than once in their recent history, the utilization of Markov-switching models is fitting, as the inflationary process in those settings does not follow a linear process, but rather, changes, often brusquely, within short time intervals. Analyzing inflation as a non-linear process subject to regime changes is the principal justification for the utilization of a Markov-switching model in an economy that has experienced wild price fluctuations over time. The rest of the paper is organized as follows: a brief literature review is provided in Section 2; Section 3 presents the Markov-Switching regime model; Section 4 introduces the data and the empirical results, and Section 5 concludes
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