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Fiscal Policy and Inflation: Understanding the Role of Expectations in Mexico

Bernabe Lopez-Martin (), Ramírez de Aguilar Alberto and Daniel Samano ()

No 2018-18, Working Papers from Banco de México

Abstract: This paper estimates a hidden Markov model where inflation is determined by government deficits financed through money creation and by expectations dynamics. The baseline model, proposed by Sargent et al. (2009) is able to distinguish between causes and remedies of hyperinflation, such as persistent or transitory shocks to fiscal deficits, and the de-anchoring of inflation expectations. The estimated sequence of monetized deficits provides an adequate account of inflation for the period 196994. The paper then extends the model to analyze the possibility that fiscal policy can affect inflation expectations in a context of Central Bank independence, as is the case of Mexico after 1994. Evidence is found that the exchange rate and sovereign interest rate spreads influence the evolution of inflation.

Keywords: Inflation; Inflation Expectations; Fiscal Deficit (search for similar items in EconPapers)
JEL-codes: E31 E42 E52 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2018-10
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