A factorial decomposition of inflation in Peru: an alternative measure of core inflation

A dynamic factorial decomposition model of inflation is estimated using Peruvian monthly data for January 1995-July 2008. This model allows the identification of changes in three relevant inflation components: idiosyncratic relative prices, aggregate relative prices and absolute prices. Furthermore, following Reis and Watson (2007), the model allows measuring pure inflation as the common factor in the inflation rate that has a proportionate effect to all prices and that is not correlated with relative-price changes at any period of time. This pure inflation estimate relates closely to standard measures of core inflation. The results are robust to different lag structures and various stochastic assumptions on the estimated factors.