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

Roberto Valencia Arriaga Julio Lopez Gallardo
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Roberto Valencia Arriaga Julio Lopez Gallardo: Universidad Nacional Autónoma de México, Universidad Autónoma del Estado de México

PSL Quarterly Review, 2015, vol. 68, issue 274, 214-237

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.

Keywords: inflation targeting; Mexico; interest rate; exchange rate (search for similar items in EconPapers)
JEL-codes: E11 E12 E43 E52 (search for similar items in EconPapers)
Date: 2015
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