Alternatives to inflation targeting in Mexico

The paper addresses Mexico’s experience with inflation targeting, which became operational in the aftermath of the 1994/95 tequila crisis. Using VAR econometrics over the post‐1980 time series data, we find that monetary policy of the Banco de México was asymmetric with respect to exchange rate movements – tightening when exchange rates depreciated, but not loosening when exchange rates appreciated. This lent a bias in favor of an over‐valued exchange rate, leading to contractionary effects on output. We propose a more ‘neutral’ monetary policy so that the central bank of Mexico responds symmetrically to real exchange rate movements and thereby avoids the bias toward over‐valuation. This policy may continue to be implemented within the boundaries of inflation targeting wherein the central bank would promote a ‘stable and competitive’ real exchange rate by establishing a sliding floor to the exchange rate in order to prevent excessive appreciation, but by allowing it to float freely otherwise.