Heterogeneous effects of monetary policy on prices: Evidence from Costa Rica

We explore the effects of unanticipated monetary policy shocks on prices in Costa Rica, a small and highly open economy. To address endogeneity concerns arising from the forward-looking behavior of policymakers, we construct an instrumental variable based on the exogenous component of policy rate changes following Romer & Romer (2004) and estimate impulse responses using a Local Projections framework. We find that a contractionary monetary policy shock has a negative and statistically significant effect on the consumer price index (CPI), with effects becoming significant after three-quarters and remaining persistent thereafter. The results are robust when using core CPI and the GDP deflator. We also find heterogeneity in the timing and magnitude of the effects across the different components of the CPI. Evidence suggests that price regulations and price stickiness decrease the magnitude of the effect of the policy rate. The accumulated effects are largest for food and non-alcoholic beverages and food away from home and lodging, whereas communication services and alcoholic beverages and tobacco do not exhibit statistically significant cumulative effects after six quarters. These results can be useful to conduct a more effective and less costly monetary policy.