This document outlines a study examining the sources of inflation in Puerto Rico using a structural VAR analysis. It includes motivation for the study from Puerto Rico's historically higher inflation volatility compared to the US. The goal is to examine the role of external and domestic shocks on headline and group-level inflation. The methodology employs a Blanchard-Quah identification scheme. Key outcomes show domestic demand shocks are the most important source of inflation changes, while federal transfers and oil prices also influence fluctuations. Conclusions discuss limitations and implications for monetary policy effectiveness.

1. The Sources of Inflation in Puerto Rico: A
Structural VAR Analysis
César R. Sobrino, Ph.D.
1Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus
2XX Encuentro de Investigación- UAGM
04/21/2023
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 1 / 18

2. Outline
1 Motivation
2 Goal
3 Literature Review
4 Methodology
Data
Variable Definitions
5 Outcomes
6 Conclusions
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 2 / 18

3. Motivation
Motivation
Persistent high inflation for most economies. In 2022, double-digit
inflation in almost half the world (CEPAL (2022) & Kryvtsov
et al. (2023) & Ball et al. (2022))
After declaring the COVID-19 pandemic:
Supply chain crisis: Internal and external (China) causes
Food shortages
Russian invasion of Ukraine in 2022
Higher prices in wheat, vegetable oils, etc.
Central Banks apply tight monetary policies to stabilize inflation.
(Lindé et al. (2023))
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 3 / 18

4. Motivation
Motivation
From 1984 - 2021, the volatility of inflation in Puerto Rico has
been higher than that of the US.
Puerto Rico United States
Mean 1.83% 2.68%
Standard deviation 1.96% 1.24%
Coefficient of variation 106.86% 46.23%
Puerto Rico, a US territory, is affected by external shocks such as
the Federal Reserve policy rate, federal transfers, oil prices, and
the Merchant Act.
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 4 / 18

5. Motivation
Motivation
Source: Institute of Statistics of Puerto Rico $ Federal Reserve of St. Louis (own elaboration)
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 5 / 18

6. Motivation
Motivation
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 6 / 18

7. Motivation
Questions
What is the importance of the Federal Reserve monetary policy on
the inflation rate and inflation per group?
What is the role of the US federal transfers on the inflation rate
and inflation per group?
What is the role of the oil price on the inflation rate and inflation
per group?
What is the role of output growth in PR on the inflation rate and
inflation per group?
What is the role of domestic demand in PR on the inflation rate
and inflation per group?
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 7 / 18

8. Goal
Goal
The goal of this study is to examine the role of external and domestic
shocks on the inflation rate (headline) and on the inflation of each group
To run this analysis is employed a structural VAR, including long-run
restrictions
Forecast error variance decomposition
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 8 / 18

9. Literature Review
Previous Empirical Literature
Le & Pfau (2009) The effects of monetary policy on inflation in
Vietnam
Kelesbayev et al. (2022) The effects of the oil price shock on
inflation: The Case of Kazakhstan
Balatti (2020) small and large advanced open economies are
exposed to global fluctuations to a comparable extent
Michail et al. (2022) the relationship between inflation and
shipping costs. Following a shock in freight rates, the most
hard-hit sectors appear to be garments and major household
appliances. (Euro Area)
Carrière-Swallow et al. (2023) Shipping Costs and Inflation
(sample of 46 countries). 1% increase in global shipping costs
increases domestic inflation by about 0.15 %, over 12 months
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 9 / 18

10. Methodology
Methodology
1 To run our analysis, we set the following reduced VAR specification
2 Using a Blanchard & Quah (1988)’ specification, I identify 5
structural shocks:
Domestic (Puerto Rico)
Permanent shock to the inflation rate (demand shock). The only
shock which is temporary to the real GDP growth rate.
Permanent shock to the real GDP growth rate (supply shock)
External
Permanent shock to the Federal Reserve Policy Rate
Permanent shock to the Oil Price
Permenent shock to the US Federal Transfers
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 10 / 18

11. Methodology Data
Data
Quarterly data from 1985:01 to 2022:01
We collect the consumer price index for all groups and per group
from the Statistical Institute of PR
The Planning Board of Puerto Rico provides the and real GDP
and the US Federal Transfers
Federal Reserve of St Louis web page provides the Federal Reserve
Policy Rate, the Federal Funds Rate, and the West Texas
Intermediate Crude Oil Price
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
04/21/2023 11 / 18

12. Methodology Variable Definitions
Variable Definitions
Headline Inflation (Percent Change of Consumer Price Index (all
groups (8))
Groups
Apparel: women, men, kids, etc.
Education and communication: tuition, child care centers, stamps, other
post office services, etc.
Food: beef, poultry, sea food, fresh vegetables, fresh fruits, elaborated
fruits and vegetables, baked goods, beverages, etc.
Medical care: prescription and nonprescription drugs, vaccines,
laboratory, hospital expenses, medical expenses, health insurance, etc.
Transportation: car price, car maintenance, fuel, car insurance, public
transportation, etc.
Housing: rent, utilities, furniture, etc.
Entertainment: services, sport implements, pets and pet goods, books,
magazines, etc.
Others: personal care goods personal care services, etc.
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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13. Outcomes
Outcomes: Headline Inflation
TABLE I: Forecast Error Variance Decomposition (%)
Quarters Policy Federal Oil Supply Demand
Rate Transfers
Headline Inflation
1 0.0 31.3 27.0 0.1 41.6
2 1.1 29.4 29.3 0.2 40.1
3 2.7 31.4 26.1 1.2 38.6
4 4.7 30.8 24.1 1.8 38.6
5 8.5 29.6 23.1 1.8 36.9
10 13.8 28.0 19.5 7.9 30.7
15 18.6 29.1 17.7 7.8 26.8
20 18.6 28.8 17.9 7.9 26.8
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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14. Outcomes
Outcomes: Groups- Average over 20 quarters
TABLE II: Forecast Error Variance Decomposition (%)
Policy Federal Oil Supply Demand
Rate Transfers
Food 13.3 26.2 5.6 1.1 53.8
Medical Care 6.1 9.1 17.0 18.9 48.8
Housing 4.4 13.8 5.2 6.4 70.2
Education 9.4 15.9 9.8 20.4 44.4
Transportation 4.5 19.5 17.4 2.8 55.8
Entertainment 8.1 16.0 29.7 37.1 9.2
Apparel 6.7 1.2 15.2 16.7 60.3
Other 6.2 18.2 22.8 9.9 42.9
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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15. Outcomes
Outcomes: Summary
The most important source of inflation changes is the demand
shocks
Federal transfers and oil price shocks play a secondary role in
inflation variations
The domestic demand shocks are also the most important source
for all groups but Entertainment
The oil price shock plays a bigger role in Entertainment and
Others groups
Across groups, the Fed monetary policy, and the Federal Transfers
are most important in the Food Group
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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16. Conclusions
Conclusions
After the COVID-19 surge, the main source of inflation was a
supply-side crisis
Puerto Rico, the main source of inflation changes is the demand
shock
External shocks such as federal transfers and oil price shocks are
important in inflation fluctuations
Fed monetary policy shocks play a small role in inflation
variations. Ineffective monetary policy?
Limitation: Shipping costs are not included (The Merchant Marine
Act of 1920 )
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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17. Conclusions
References I
Balatti, M. (2020). Inflation volatility in small and large advanced open
economies.
Ball, L. M., Leigh, D., & Mishra, P. (2022). Understanding US
Inflation During the COVID Era. Technical report, National Bureau
of Economic Research.
Carrière-Swallow, Y., Deb, P., Furceri, D., Jimenez, D., & Ostry, J. D.
(2023). Shipping costs and inflation. Journal of International Money
and Finance, 130, 102771.
CEPAL, N. (2022). United states economic outlook: Inflation trends
post covid-19.
Kelesbayev, D., Myrzabekkyzy, K., Bolganbayev, A., &
Baimaganbetov, S. (2022). The effects of the oil price shock on
inflation: the case of kazakhstan. International Journal of Energy
Economics and Policy, 12(3), 477–481.
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
The Sources of Inflation in Puerto Rico: A Structural VAR Analys
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18. Conclusions
References II
Kryvtsov, O., MacGee, J. J., & Uzeda, L. (2023). The 2021–22 Surge
in Inflation. Technical report, Bank of Canada.
Le, H. V. & Pfau, W. D. (2009). A vector autoregression (var) analysis
of the monetary transmission mechanism in vietnam. Mimeo
(National Graduate Institute for Policy Studies, Vietnam).
Lindé, J., Trabandt, M., & Harding, M. (2023). Understanding
Post-COVID Inflation Dynamics. Technical report, International
Monetary Fund.
Michail, N. A., Melas, K. D., & Cleanthous, L. (2022). The relationship
between shipping freight rates and inflation in the euro area.
International Economics, 172, 40–49.
César R. Sobrino, Ph.D. ( Division of Business, Tourism & Entreprenuership- UAGM, Gurabo Campus, XX Enc
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