Monetary Policy Rules in a Small Open Economy: An Application to Mexico

Alejandro Villagómez () and Juan Ignacio Hernández
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Alejandro Villagómez: Division of Economics, CIDE

No DTE 454, Working Papers from CIDE, División de Economía

Abstract: We estimate a small-scale macro model for the Mexican economy under the New Keynesian framework. We then estimate alternative interest rate rules for Mexico, and use the results from both exercises to evaluate the performance of the Bank of Mexico against a set of optimality principles derived in the New Keynesian literature. We show that the Bank of Mexico holds a preference for stabilizing not only inflation around target, but also acts to achieve an output gap close to zero. Furthermore, we show the central bank responds non-linearly to real exchange rate depreciations. We also show that, although the central bank has attempted to contain inflation, it has not conclusively satisfied the Taylor principle, so moderate inflation during the period may be partly a consequence of a favorable macroeconomic environment, rather than active policy.

Keywords: Monetary Policy Rules; Small Open Economy; Mexico; New Keynesian; Banxico (search for similar items in EconPapers)
JEL-codes: E52 F43 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2009-08
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