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Macroeconomic effects of high interest rate policy: Mexico’s experience

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  • Julio Lopez Gallardo, Roberto Valencia Arriaga

    (Universidad Nacional Autónoma de México, Universidad Autónoma del Estado de México)

Abstract

We study the effects on the price level and on GDP and its components, of the high interest rate policy implemented in Mexico under the inflation targeting (IT) scheme. We specify a macroeconomic model inspired by the theory of the effective demand, and on this basis we demonstrate, through comparative statics, the complex set of relationships between the variables involved, and the chain of reactions that a shock to the interest rate is likely to provoke. Our main conclusions show that the interest rate rise may be instrumental to control inflation. However, this rise contributes to appreciate the exchange rate, which is the main channel through which inflation is tamed. Currency appreciation raises the share of wages in GDP even as it reduces the debt service of firms indebted in dollars. It follows that the interest rate rise may have, under certain conditions, an indirect positive impact on output. Thus, our results diverge from those entailed by the theory that is at the basis of the inflation-targeting strategy, and even from some contemporary non-conventional approaches.

Suggested Citation

  • Julio Lopez Gallardo, Roberto Valencia Arriaga, 2015. "Macroeconomic effects of high interest rate policy: Mexico’s experience," PSL Quarterly Review, Economia civile, vol. 68(274), pages 214-237.
    • Handle: RePEc:psl:pslqrr:2015:33
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    File URL: http://ojs.uniroma1.it/index.php/PSLQuarterlyReview/article/view/13169/12983
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    inflation targeting; Mexico; interest rate; exchange rate;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E11 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Marxian; Sraffian; Kaleckian
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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