Fiscal%20Policy%20and%20Inflation%3A%20Understanding%20the%20Role%20of%20Expectations%20in%20Mexico

Working Papers

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


CODE: IDB-WP-893
AUTHOR(s): Bernabé López-Martín, Alberto , Ramírez de Aguilar, Daniel Samano
PUBLISHED: August 2018
LANGUAGE: English
RELATED TOPICS: Macroeconomics
DOWNLOAD FILE IN: English

Abstract:

This paper estimates a hidden Markov model where ination is determined by government decits nanced through money creation and/or by destabilizing expectations dynamics (expectations can potentially divorce ination from fundamentals). The baseline model, proposed by Sargent et al. (2009), is used to analyze the interaction between scal decits, ination expectations, and ination in Mexico. The model is able to distinguish between causes and remedies of hyperination, such as persistent or transitory shocks to seigniorage-nanced scal decits, de-anchoring of ination expectations from scal fundamentals, and cosmetic (non-fundamental) monetary reforms. The behavior of monetized decits provides an adequate account of high ination episodes and stabilizations for the period 1969-1994. The paper then extends the model to analyze the possibility that scal policy can aect ination 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 inuence the evolution of aggregate prices.

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