Propagation of inflationary shocks in Chile

When a specific price is affected by a shock, this may spread to other prices and thus affect the overall inflation rate by more than the initial effect. This phenomenon is known as propagation of inflationary shocks and is the subject investigated in the present paper. It is argued that two-dimensional VAR models, with an imposed Cholesky decomposition, are suitable for the propagation analysis when the data vector includes the component affected by the initial shock and the rest of the CPI basket. The empirical analysis with annual Chilean inflation rates suggests that the duration of propagation has generally diminished after September 1999, even though the impact is higher for a couple of divisions. Propagation is statistically significant for most of the divisions included in the consumer basket, but the effects of propagation are quite disperse, which should be taken into account when evaluating policy options in response to increasing inflation rates.