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

Bernabe Lopez-Martin, Alberto Ramirez de Aguilar and Daniel Samano

No 9025, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: We exploit a hidden Markov model where inflation is determined by government deficits financed through money creation and/or by destabilizing expectations dynamics (expectations can potentially divorce inflation from fundamentals). The baseline model, proposed by Sargent et al. (2009), is used to analyze the interaction between fiscal deficits, inflation expectations, and inflation in Mexico. The model is able to distinguish between causes and remedies of hyperinflation, such as persistent or transitory shocks to seigniorage-financed fiscal deficits, deanchoring of inflation expectations from fiscal fundamentals, and cosmetic (non-fundamental) monetary reforms. The behavior of monetized deficits provides an adequate account of high inflation episodes and stabilizations for the period 1969-1994. We then extend the model to analyze the possibility that fiscal policy can affect inflation expectations in a context of Central Bank independence, as is the case in Mexico after 1994. We find evidence that the exchange rate and sovereign interest rate spreads influence the evolution of aggregate prices.

Keywords: Inflation expectations; Fiscal policy; Inflation (search for similar items in EconPapers)
JEL-codes: E31 E42 E52 E63 (search for similar items in EconPapers)
Date: 2018-08
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://publications.iadb.org/publications/english ... ations-in-Mexico.pdf (application/pdf)

Related works:
Working Paper: Fiscal Policy and Inflation: Understanding the Role of Expectations in Mexico (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:idb:brikps:9025

DOI: 10.18235/0001239

Access Statistics for this paper

More papers in IDB Publications (Working Papers) from Inter-American Development Bank Contact information at EDIRC.
Bibliographic data for series maintained by Felipe Herrera Library ().