Abstract
This paper evaluates the extent to which Mexican monetary policy in 1994 may have loosened, or not tightened sufficiently, in the lead up to the devaluation. Using econometric models of money demand, we find evidence that the high monetary base growth reflected strong positive shocks to the demand for money, not supply. Next, we show that interest rates rose only moderately less in 1994 than was predicted by an estimated reaction function. Thus to have maintained the peg, the authorities would have needed to intensify their response to exchange market developments (to alter their reaction function) at a time when concerns over the banking sector and the economy pointed to a relaxation of monetary policy.
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