Money Neutrality: An Empirical Assessment for Mexico

Abstract

The quantity theory of money assumes that money itself is neutral with respect to real output, both in the long and short term. Therefore, this last period should not be affected by changes in money supply. A review of the literature is carried out in order to provide a framework for the empirical analysis. To test the above proposition for Mexico, M1 is used, while GDP, duly adjusted for inflation stands for output. The period under consideration covers from the first quarter of 1993 to the first quarter of 2018. The results expose a cubic function. For the long term and with respect to M1, the price elasticity is positive with a substantial coefficient (10.03). In its squared portion, the coefficient is inelastic and negative (-0.49). Finally, the cubic coefficient is close to zero (0.01). These three coefficients bear a one period lag. Besides, a dummy variable comprising the four quarters of 1995, when the Mexican economy experienced a recession, was introduced. In the short term, the coefficient for the straight section is considerably large (38.19), being negative and elastic in its square tranche (-1.81), and almost negligible in its cubic portion (0.03). As a result of the above estimates, while there has been a considerable effect in real output as a result of increases in the money supply, particularly in the early years considered, its value has been receding at a considerable pace. These results apply in the long as well as in the short term. The only difference in this similar pattern is that such effect has been stronger during the short term. With respect to the theoretical tenets underling the subject, it should be observed that the effects of money supply in real output are mixed, depending on the periods under consideration.