Investment and the real exchange rate’s profitability channel in Mexico

Abstract

The paper estimates different versions of an equation for private investment in Mexico during the post-liberalization period 1988–2013, with the aim of studying the operation of the recently discussed real exchange rate’s profitability channel. During this period, the real exchange rate (RER) was broadly positively correlated with the Mexican price/wage ratio and the Mexican/US relative profit margin in the manufacturing sector, particularly so when the RER experienced large fluctuations, before the end of disinflation in the early 2000s. In the estimations, the effect of the profit margin appears to be ‘deeper’, wiping out the effect of the RER when the two variables are included together in the investment equation. From this, the paper argues that the positive effect of the RER on investment, observed in previous studies that omitted the profit margin, reflects indirectly the positive link of the RER with the profit margin, supporting the existence of a profitability channel in Mexico.