Macroeconomic Effects of High Interest Rate Policy: Mexico's Experience

PSL Quarterly Review, vol. 68 n. 274 (September 2015), 215-237

23 Pages Posted: 22 Jan 2018

See all articles by Julio Lopez Gallardo

Julio Lopez Gallardo

National Autonomous University of Mexico (UNAM) - Instituto de Investigaciones Económicas

Roberto Valencia Arriaga

National Autonomous University of Mexico (UNAM)

Date Written: September 15, 2015

Abstract

We study the effects of the high interest rate policy implemented in Mexico under the inflation targeting (IT) scheme on the price level and on GDP and its components. We specify a macroeconomic model inspired by the theory of the effective demand, and on this basis we demonstrate, through comparative statics, the complex set of relationships between the variables involved, and the chain of reactions that a shock to the interest rate is likely to provoke. Our main conclusions show that an interest rate rise may be instrumental to control inflation. However, this rise contributes to appreciate the exchange rate, which is the main channel through which inflation is tamed. Currency appreciation raises the share of wages in GDP even as it reduces the debt service of firms indebted in dollars. It follows that the interest rate rise may have, under certain conditions, an indirect positive impact on output. Thus, our results diverge from those entailed by the theory that is at the basis of the inflation-targeting strategy, and even from some contemporary non-conventional approaches.

Keywords: Inflation targeting, Mexico, Interest rate, Exchange rate

JEL Classification: E52, E11, E12, E43

Suggested Citation

Lopez Gallardo, Julio and Valencia Arriaga, Roberto, Macroeconomic Effects of High Interest Rate Policy: Mexico's Experience (September 15, 2015). PSL Quarterly Review, vol. 68 n. 274 (September 2015), 215-237. Available at SSRN: https://ssrn.com/abstract=3102113

Julio Lopez Gallardo (Contact Author)

National Autonomous University of Mexico (UNAM) - Instituto de Investigaciones Económicas ( email )

Av. Universidad 3000
Edif. de las Oficinas Administrativas 2
04510 Ciudad Universitaria
Mexico
55 77 62 03 (Phone)
57 50 10 95 (Fax)

Roberto Valencia Arriaga

National Autonomous University of Mexico (UNAM) ( email )

Circuito Mario de la Cueva s/n
Lomas de las Palmas, 52760
Mexico

Register to save articles to
your library

Register

Paper statistics

Downloads
31
Abstract Views
187
PlumX Metrics