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Monetary policy rules in a small open economy: an application to Mexico

We estimate a small-scale macro model for the Mexican economy under the New Keynesian (NK) framework and alternative interest rate rules for Mexico. With these results we evaluate the performance of the Bank of Mexico against a set of optimality principles derived in the NK literature. Our system estimation results show that the Bank of Mexico holds a preference for stabilizing not only inflation around target, but also acts to achieve an output gap close to zero. Furthermore, we find that the central bank responds non-linearly to real exchange rate depreciations. We also find that the central bank has actively attempted to neutralize demand and supply shocks through monetary policy that is consistent with the Taylor principle.

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Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): XV (2012)
Issue (Month): (November)
Pages: 259-286

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Handle: RePEc:cem:jaecon:v:15:y:2012:n:2:p:259-286
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  1. Menzie D. Chinn, 2008. "Non-linearities, Business Cycles and Exchange Rates," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(3), pages 219-239, November.
  2. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  3. Martin Eichenbaum & Charles L. Evans, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 110(4), pages 975-1009.
  4. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-42, November.
  5. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  6. Alejandro Villagómez & Bernardo Roth Rivero, 2007. "Fiscal Policy and National Saving in Mexico, 1980-2006," Working papers DTE 387, CIDE, División de Economía.
  7. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
  8. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies.
  9. MOONS, Cindy & GARRETSEN, Harry & VAN AARLE, Bas & FORNERO, Jorge, 2007. "Monetary policy in the new-Keynesian model: An application to the Euro-Area," Working Papers 2007014, University of Antwerp, Faculty of Applied Economics.
  10. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  11. Wicksell, Knut, 1907. "The Influence of the Rate of Interest on Prices," History of Economic Thought Articles, McMaster University Archive for the History of Economic Thought, vol. 17, pages 213-220.
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