MONETARY-POLICY IN THE END-GAME TO EXCHANGE-RATE BASED STABILIZATIONS- THE CASE OF MEXICO

This paper evaluates the extent to which Mexican monetary policy in 19 94 may have loosened, or not tightened sufficiently, in the lead up to the devaluation. Using econometric models of money demand, we find ev idence that the high monetary base growth reflected strong positive sh ocks to the demand for money, not supply. Next, we show that interest rates rose only moderately less in 1994 than was predicted by an estim ated reaction function. Thus to have maintained the peg, the authoriti es would have needed to intensify their response to exchange market de velopments (to alter their reaction function) at a time when concerns over the banking sector and the economy pointed to a relaxation of mon etary policy.