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Monetary policy in the end-game to exchange-rate based stabilizations: the case of Mexico

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  • Kamin, Steven B.
  • Rogers, John H.

Abstract

Exchange-rate based stabilizations, while useful in accelerating the disinflation process, typically lead to overvalued exchange rates and large current account deficits. These factors, in turn, make it difficult to sustain exchange rate pegs, placing heaving demands upon monetary policy to sustain exchange-rate based programs in their later phases. This paper evaluates the extent to which Mexican monetary policy in 1994 may have loosened, or not tightened sufficiently, in the lead up to the devaluation of the peso that December. Using econometric models of the demand for money, we find evidence that the high growth of the monetary base in 1994 reflected strong positive shocks to the demand for money, not to its supply. Next, we estimate a monetary policy reaction function for Mexico. Based on this estimate, we argue that interest rates rose only moderately less in 1994, in response to downward pressure on the peso and on international reserves, than was predicted by the authorities' reaction function. This result is qualified somewhat by our finding that if interest rates are modeled as reacting to reserves net of Tesobonos, rather than gross reserves, the measured deviation of actual from predicted interest rates would have been much greater. However, the relative complacency with which both the authorities and the market viewed the build-up in Tesobonos, at least until late in 1994, suggests that the reaction function based on net reserves probably does not capture "normal" monetary policy behavior. Our findings suggest that in order to have maintained the peg, the authorities would have needed to intensify their response to exchange market developments--that is, to alter their reaction function--at a time when concerns over the health of the banking sector, and of the economy more generally, would have pointed to a relaxation of monetary policy. Insofar as such tightenings of monetary reaction functions are difficult to achieve, Mexico's experience sug

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 41 (1996)
Issue (Month): 3-4 (November)
Pages: 285-307

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Handle: RePEc:eee:inecon:v:41:y:1996:i:3-4:p:285-307

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Web page: http://www.elsevier.com/locate/inca/505552

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References

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  1. Rose, A.K. & Svensson, L.E.O., 1993. "European Exchange Rate Credibility Before the Fall," Papers 542, Stockholm - International Economic Studies.
  2. Nora Lustig, . "The Mexican Peso Crisis: The Foreseeable and the Surprise," Discussion Papers 114, Brookings Institution International Economics.
  3. Rebelo, Sérgio, 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," CEPR Discussion Papers 1220, C.E.P.R. Discussion Papers.
  4. Martin Uribe, 1995. "Exchange-rate based inflation stabilization: the initial real effects of credible plans," International Finance Discussion Papers 503, Board of Governors of the Federal Reserve System (U.S.).
  5. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  6. Steven B. Kamin & John H. Rogers, 1996. "Monetary policy in the end-game to exchange-rate based stabilizations: the case of Mexico," International Finance Discussion Papers 540, Board of Governors of the Federal Reserve System (U.S.).
  7. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
  8. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," Harvard Institute of Economic Research Working Papers 1760, Harvard - Institute of Economic Research.
  9. Carlos A. Végh, 1992. "Stopping High Inflation: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 626-695, September.
  10. Hendry, David F & Ericsson, Neil R, 1991. "An Econometric Analysis of U.K. Money Demand in 'Monetary Trends in the United States and the United Kingdom' by Milton Friedman and Anna Schwartz," American Economic Review, American Economic Association, vol. 81(1), pages 8-38, March.
  11. Carlos A. Végh Gramont, 1991. "Stopping High Inflation," IMF Working Papers 91/107, International Monetary Fund.
  12. Kiguel, Miguel A & Liviatan, Nissan, 1992. "The Business Cycle Associated.with Exchange Rate-Based Stabilizations," World Bank Economic Review, World Bank Group, vol. 6(2), pages 279-305, May.
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Citations

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Cited by:
  1. Kolver Hernandez, 2006. "State-Dependent Nominal Rigidities & Disinflation Programs in Small Open Economies," Working Papers 06-13, University of Delaware, Department of Economics.
  2. Melike Altinkemer, 2001. "Capital Inflows And Central Bank’s Policy Response," Discussion Papers 0103, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  3. Enrique G. Mendoza & Martin Uribe, 1998. "The business cycles of currency speculation: a revision of the Mundellian framework," International Finance Discussion Papers 617, Board of Governors of the Federal Reserve System (U.S.).
  4. Steven B. Kamin & John H. Rogers, 1996. "Monetary policy in the end-game to exchange-rate based stabilizations: the case of Mexico," International Finance Discussion Papers 540, Board of Governors of the Federal Reserve System (U.S.).
  5. Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Stabilization Policy and the Costs of Dollarization," Departmental Working Papers 200006, Rutgers University, Department of Economics.
  6. Kumhof, Michael, 2000. "A quantitative exploration of the role of short-term domestic debt in balance of payments crises," Journal of International Economics, Elsevier, vol. 51(1), pages 195-215, June.
  7. Marco del Negro & Francesc Obiols-Homs, 2001. "Has monetary policy been so bad that it is better to get rid of it? The case of Mexico," Proceedings, Federal Reserve Bank of Cleveland, pages 404-439.
  8. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 239-296, December.
  9. Joseph A. Whitt, Jr., 1996. "The Mexican peso crisis," Economic Review, Federal Reserve Bank of Atlanta, issue Jan, pages 1-20.
  10. Enrique G. Mendoza & Martin Uribe, 1999. "The Business Cycles of Balance-of-Payment Crises: A Revision of Mundellan Framework," NBER Working Papers 7045, National Bureau of Economic Research, Inc.
  11. Kamin, Steve B. & Rogers, John H., 2000. "Output and the real exchange rate in developing countries: an application to Mexico," Journal of Development Economics, Elsevier, vol. 61(1), pages 85-109, February.
  12. William C. Gruben & John H. Welch, 2001. "Banking and currency crisis recovery: Brazil's turnaround of 1999," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q IV, pages 12-23.
  13. Prof.Dr. Cevat GERNI & Doc.Dr. O. Selcuk EMSEN & Dr. M. Kemal DEGER, 2005. "Erken Uyari Sistemlerý Yoluyla Turkiye’Deki Ekonomik Krizlerin Analizi," Istanbul University Econometrics and Statistics e-Journal, Department of Econometrics, Faculty of Economics, Istanbul University, vol. 2(1), pages 39-62, November.
  14. Carlos E. Zarazaga, 1995. "Argentina, Mexico, and currency boards: another case of rules versus discretion," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q IV, pages 14-24.
  15. Enrique G. Mendoza & Martin Uribe, 1999. "Devaluation Risk and the Syndrome of Exchange-Rate-Based Stabilizations," NBER Working Papers 7014, National Bureau of Economic Research, Inc.

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