Fear of floating or monetary policy as usual? A structural analysis of Mexico's monetary policy

This paper uses Bayesian methods to estimate a small open economy dynamic stochastic general equilibrium (DSGE) model for the period in Mexico after the 1994 crisis. I consider a Taylor rule as the expression of the evolution of monetary policy to gauge its response to the exchange rate in the post-crisis period. The estimation results favor a consistent response of the nominal interest rate to the short-run nominal exchange rate after 1994. Although fear of floating is present, Mexico's monetary policy has taken steps toward a credible free-floating exchange rate that targets inflation.

► I estimate a structural model for the Mexican economy that includes a Taylor rule as the expression of monetary policy. ► I gauge the extent to which the interest rate responds to inflation or the exchange rate in the postcrisis period. ► To disentangle if the Mexican central bank's post-1994 monetary policy targeted inflation or reflected fear of floating. ► The results favor a consistent response of the central bank to movements in the exchange rate after the crisis. ► Although fear in floating is present, responding to inflation has become important since the 1994 crisis.