Mexico's macroeconomic performance: an analysis using co-integration techniques

Abstract

In the context of the monetary approach to the balance of payments, co-integration and vector autoregressions techniques are applied to Mexican data. The statistical evidence suggests that, despite the presence of nonstationarity in Mexico's data, a long-run relationship seems to exist between changes in international reserves and the exchange rate and changes in domestic credit, i.e., these variables seem to be co-integrated. In addition, multivariate Granger causality tests together with innovation accounting support a negative bidirectional causality between these variables. This finding does not support the unidirectional causality of the monetary approach, or its assumption that domestic credit is exogenous. The bidirectional causality does indicate that Mexico's monetary authorities adjust domestic assets to sterilize exogenous balance-of-payments deficits on the monetary base in an attempt to control its monetary policy;Moreover, co-integration and vector autoregressions techniques are again applied to Mexico's data to test whether purchasing power parity held during the period 1960-1988. The null hypothesis of non co-integration (e.g. purchasing power parity did not hold) was rejected in favor of accepting purchasing power parity. An estimated error-correction model suggests that Mexican prices and/or the peso price of a U.S. dollar adjusted as to maintain purchasing power parity during that period. This is also supported by innovation accounting and Granger causality tests derived from the estimated VAR;Next, co-integration techniques are applied to Mexico's data to determine whether there exists statistical evidence of a long-run or equilibrium money demand specification during the period 1969 to 1991. Although three definitions of money supply were tested, only the monetary aggregate M3 seems to observe a long-run relationship with income and the rate of inflation. Further Chow tests detected a structural change in the money demand for M3 only after 1988.