Monetary Policy and the Balance of Payments in Mexico, 1955-75

Abstract

IN THIS PAPER we examine the balance of payments and monetary policies in Mexico during the fixed exchange rate period 1955-75. The hypothesis tested is that the balance of payments is determined by the incipient state of excess demand for money a variant of the so-called monetary approach to the balance of payments. We feel that this theory is well suited to Mexico during the Sxed rate period for two reasons. First, it is a relatively small economy that faces prices for goods and capital that are determined on world markets and over which it has little control. Second, though considered an underdeveloped country, Mexico has a relatively advanced financial structure headed by a central bank, which, over most of the period, was concerned with the external balance (the balance of payments) as well as internal economic development. Thus Mexico offers not only the conditions necessary for testing a monetary model of a small open economy, but it also adds interesting economic insights into the model's policy use, especially since Mexican economic development depended greatly upon an expanding and maturing financial structure. For both political and economic reasons, one of the most important goals for Mexican monetary policy was the maintenance of a fixed exchange rate. To maintain the stable exchange rate and to achieve the goals of stable prices and of