Estimating Venezuelas Latent Inflation

Abstract

Percent variation of the consumer price index (CPI) is the inflation indicator most widely used. This indicator, however, has some drawbacks. In addition to measurement errors of the CPI, there is a problem of incongruence between the definition of inflation as a sustained and generalized increase of prices and the traditional measure associated with the CPI. We use data from 1991 to 2005 to estimate a complementary indicator for Venezuela, the highest inflation country in Latin America. Latent inflation is defined as that component of measured inflation that has no impact on real output in the long-run. This notion, consequently, is consistent with a vertical long-run Phillips curve and therefore it is grounded on economic theory. Latent inflation is constructed placing dynamic restrictions on a structural vector auto regression system. We find that latent inflation reflects more closely the generalized and sustained price increases most likely to be impacted by monetary policy. Our results are consistent with the identifying restrictions and with the theoretical definition of inflation.