Preemptive policy strikes and bond price stability: A Study on the Credibility of the Monetary Policy in Mexico under Inflation Targets

From the aftermath of the crisis of 1995, monetary authorities in Mexico have employed a preemptive monetary policy mechanism known as the 'short' to affect interest rates in the first instance and then, in the medium and long term, to control inflation expectations. By using an Exponential- GARCH framework, this document examines the effect of the 'short' on the stability of the term structure under Money growth Targets (MT) and Inflation Targeting (IT). Long-bond rates signal the course in which short interest rates ought to go and contain information about the persistence and direction of inflation expectations. When these expectations surpass the official target, the credibility of the Banco de México to achieve such target is at peril. The findings of this research are twofold, first, the introduction of IT indeed enhances the credibility of the monetary framework and, second, the preemptive changes in the monetary policy ('short' variations) under this framework are considered not transparent and inconsistent.