Inflation Dynamics under Fiscal Deficit Regime Switching in Mexico

Manuel Ramos Francia, Santiago Garcia-Verdu and Sánchez-Martínez Manuel

No 2018-21, Working Papers from Banco de México

Abstract: We explore the dynamics of inflation, inflation expectations, and seigniorage-financed fiscal deficits in Mexico. To do so, we estimate the model in Sargent, Williams, and Zha (2009) using Mexican CPI inflation data. This model features dual expected inflation equilibriums and regime switching in the mean and variance of the fiscal deficit probability density function. We examine the dynamics of inflation and mean fiscal deficit regimes. In addition, we comment on the extent to which our results match to key economic events. Mexico has successfully stabilized inflation expectations for the past decades, an achievement for which fiscal policy has been fundamental. Nevertheless, this does not preclude the possibility of an increase in the expected price level or a switch to a regime in which inflation and its expectations become unstable.

Keywords: Inflation; Inflation Expectations; Public Deficit; Fiscal Deficit; Regime-Switching; Monetary Policy; Fiscal Policy (search for similar items in EconPapers)
JEL-codes: C01 D84 E31 E52 E62 H62 (search for similar items in EconPapers)
Date: 2018-11
New Economics Papers: this item is included in nep-mac and nep-mon
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