Nonlinearities and Price Puzzle in Brazil

What is called a price puzzle is a positive and persistent response of inflation to a unit shock in the interest rate’s innovation. Using a VAR to analyse monetary policy in Brazil, this paper comes to the conclusion that when nonlinearities in the data were considered, most of this effect vanishes. This is done firstly by checking if the series are unit root processes or nonlinear trend stationary. After that a nonparametric co-trending analysis was applied. The test result favored a common nonlinear trend between inflation and the interest rate, which seems to affect the system innovation analysis, inducing most of the price puzzle effect