Working Paper: NBER ID: w0770
Authors: Robert E. Cumby; Maurice Obstfeld
Abstract: This paper is an empirical study of the Banco de Mexico's monetary policy during the 1970s. In particular, it studies the Mexican monetary equilibria and the extent to which capital mobility undermined monetary control. Estimates of a Banco de Mexico reaction function suggest that the Mexican central bank attempted to sterilize reserve flows through offsetting movements in domestic credit, at least over the second half of the decade. This finding suggests that estimates of the capital-account response to domestic credit expansion should be derived from a structural model, and we accordingly estimate an aggregative three-equation model of Mexican financial markets. The paper distinguishes between the short-run or one-quarter capital-account offset and a hypothetical long-run offset that would obtain under instantaneous asset-market adjustment. The model implies that, depending on the method of monetary expansion, between 30 and 50 percent of an expansion in domestic credit was offset by capital outflow in the same quarter. The implied long-run offsets range from 50 to 76 percent. These offset coefficients indicate that the Banco de Mexico's monetary control was exercised at a substantial cost in terms of reserve volatility.
Keywords: capital mobility; monetary policy; Mexico; sterilization; balance of payments
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital mobility (F20) | Effectiveness of monetary policy (E52) |
| Reserve flows (E50) | Domestic credit expansion (E51) |
| Domestic credit expansion (E51) | Capital outflow (F21) |
| Sterilization efforts (I19) | Reserve volatility (F31) |
| Balance of payments (F30) | Domestic credit policy (E51) |