Image Source: Eduardo Garcia 

By: Camila De Bracamonte

Edited By: Vladimir Gaberman

On February 17, Peru’s president, Jose Jeri, was impeached amid corruption allegations. Surprising? Not at all. His successor, elected by Congress, is Jose Maria Balcazar, another president in a long line of successors. Since 2018, two presidents resigned, four were removed by Congress and Peru has had eight presidents. In that same period, only one president completed a full constitutional term. Political instability is hardly new in Peru.

Despite the extraordinarily high executive turnover, Peru’s economy not only remains afloat but continues to grow. Last year, the country’s gross domestic product expanded 3.4%, and its annual inflation closed at 1.5%, the lowest rate in nearly a decade. Although inflation has since risen to 2.21%, analysts attribute the uptick to the El Niño weather phenomenon, rising global oil prices, and Peru’s recent natural gas crisis, not to political instability. Therefore, it appears that political instability has not been the determining force behind Peru’s macroeconomic outcomes. 

This raises an important question: how does an extremely politically unstable country not only keep its economy afloat but rank among the region’s most economically resilient? The main reason lies in one institution: Peru’s central bank, Banco Central de Reserva del Perú, or the BCRP.

The BCRP operates under an inflation targeting regime, in which the central bank publicly announces a specific inflation rate target and uses interest rates, along with FX intervention and reserve requirements, to keep inflation close to that benchmark. The results speak for themselves: over the past two decades, the BCRP has maintained inflation within or near its target band through commodity shocks, political crises and a global pandemic. Although the BCRP’s performance has been impressive, the framework it applies is not unusual in itself; what is unusual is how firmly it has been insulated from political interference. That insulation cannot be attributed merely to institutional culture and central bank resolve, but to the structural framework established through Peru’s constitution. To understand why this arrangement has proven so effective, one must first understand the political context that made it necessary. 

Distortionary policies emerge when those in power have preferences misaligned with the broader public interest and when institutions impose insufficient constraints on their behavior. This is not an incidental failure of governance, but a predictable outcome of political incentives, as in most scenarios, bad policies persist not because policymakers misunderstood economics, but because political constraints and the incentives they face make distortionary policies rational and convenient from their own perspective. This creates a fundamental gap between de jure reform on paper and de facto reform in practice. Only institutional changes that groups with political power cannot easily override, circumvent, or ignore are capable of achieving their objectives, because only those changes alter the underlying incentive structure rather than merely the formal rules.

This insight, developed in the literature on central bank independence, points to a key condition: reform works best under medium political constraints. Acemoglu, Johnson, Querubin, and Robinson (2008) demonstrate empirically that central bank independence reduces inflation most significantly in societies with intermediate constraints on the executive, measured through Polity IV’s constraints on the executive index. When constraints are too weak, even well-designed legal reforms are undermined by those in power. When constraints are already strong enough, distortionary policy is unlikely to have emerged in the first place. Peru’s experience fits this model precisely: constrained enough to respect institutional reform, but with enough recent memory of crisis to make compliance credible.

From the mid-1970s to the early 1980s, Peru consistently ran expenditures in excess of fiscal revenues, financing the gap by printing money. This policy culminated in triple-digit inflation by 1983. When the incoming government took power in 1985, rather than addressing the fiscal imbalances, it responded with a heterodox economic program: expansionary fiscal policy, an initial currency devaluation, and widespread price controls. Ultimately, the BCRP’s implementation of quasi-fiscal operations, activities that functioned as government spending in practice but were recorded in the central bank’s balance sheet, thereby hiding the true fiscal cost.  In the short run, aggregate demand surged, and the economy grew at roughly 9% annually for two consecutive years.

However, the program’s underlying fragility soon became apparent. It was being financed by Peru’s stock of foreign currency reserves. Once international reserves were depleted, the government, rather than adjusting course, pressured the central bank to extend credit to the public sector and state development banks, while setting the exchange-rate system in ways that forced the central bank to absorb the resulting losses. The result was the catastrophic hyperinflationary episode of 1988–1990, during which GDP contracted cumulatively by 27%.

This episode demonstrates the nature of political pressure on monetary institutions: the decisions driving the crisis were not made by the central bank, but by the government. The BCRP was, in effect, an instrument of fiscal policy rather than an independent steward of monetary stability.

By 1990, Peru’s macroeconomic position was dire. With four-digit inflation for three consecutive years, peaking at 12,377% annually in August 1990, negative international reserves of -$105 million, an external debt default, complete international financial isolation, and a cumulative GDP contraction of 27%, it was evident that the implementation of distortionary policies through fiscal dominance was detrimental to the economy. These conditions precipitated a comprehensive Stabilization Program and, ultimately, a fundamental reform of the legal framework governing the central bank.

The 1979 constitution had nominally declared the BCRP an autonomous entity, but this autonomy was largely illusory — its independence could be overridden by directing credit policy through pressure via quasi-fiscal operations and the subordination of price stability to other policy objectives. Monetary stability was established as merely one among many functions of the central bank, meaning that not all policy decisions were oriented toward price stability, creating broad scope for discretionary intervention. Critically, the constitution did not prohibit the central bank from financing the treasury. Both features enabled fiscal dominance.

The 1993 constitution corrected these flaws directly. It made every activity of the central bank subordinate to the single objective of monetary stability and prohibited the BCRP from granting financing to the Treasury, with the narrow exception of purchasing treasury securities in secondary markets within limits established by its Organic Law. Anchoring central bank independence in the constitution, rather than in ordinary legislation, was essential as it placed monetary policy beyond the reach of any sitting government, converting the BCRP into a more insulated technocratic institution. No institution can be fully insulated from political interference, and the BCRP is no exception, as board members are still presidentially appointed and informal executive pressure remains a theoretical possibility. What Peru’s constitutional framework does is raise the cost of interference substantially, requiring a level of political coordination and institutional disruption that, so far, no administration has been willing to bear. 

At the time of the reform, Peru’s political institutions imposed an intermediate level of constraint on the executive. This meant that while the country had been susceptible to distortionary policies, as evidenced by the 1979 constitutional framework, political groups lacked the power to simply override reform, as the channels that allowed autonomy to be circumvented were eliminated. The key to achieving monetary stability was therefore the elimination of fiscal dominance through a constitutionally entrenched legal framework, applied in a political environment where that framework could actually hold. The inflation targeting regime, adopted subsequently, reinforced this architecture further, institutionalizing the principle that the BCRP’s singular mandate is price stability, not fiscal accommodation.

Concerns are sometimes raised about credibility in the context of Peru’s high presidential turnover. The argument holds that frequent leadership changes signal political risk to investors, thereby weakening broader governance credibility and discouraging investment. But credibility in monetary policy is not necessarily built through government stability; it can be built through a sustained, cross-administration commitment to refrain from intervening in monetary policy as prescribed by the constitution. Therefore, a country can maintain a credible monetary framework while experiencing lower investment and lower growth because the mechanisms driving monetary credibility and investment decisions operate through distinct channels.  

That said, persistent political instability carries its own risks, even when monetary policy remains sound. Prolonged uncertainty about the broader governance environment can weigh on investment, consumption, and financial decisions, not because the BCRP’s mandate is in doubt, but because firms and investors remain uncertain about whether the wider rules of the game might change abruptly. Recent domestic economic analysis suggests that increased uncertainty is a main driver of Peru’s slower growth, from about 6.5% in 2013 to about 3% today.

The most serious threat to central bank independence would therefore be a government willing to challenge the constitutional framework directly, circumventing the BCRP’s autonomy, rather than respecting the constitutional constraint. In practice, this could mean forcing the BCRP to finance fiscal deficits, arranging politically favorable board appointments, or subordinating price stability to other policy objectives. Any of these would recreate the conditions of fiscal dominance that produced the hyperinflationary catastrophe of 1988–1990. 

So far, no Peruvian administration has gone that far. Whether that restraint holds, as political instability continues, remains the central question. Peru’s case ultimately offers a broader lesson: strong institutions, when properly designed, can outlast the governments that surround them.