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Policy mix in a small open emerging economy with commodity prices

Author

Listed:
  • André, Marine C.
  • Armijo, Alberto
  • Espidio, Sebastián Medina
  • Sandoval, Jamel

Abstract

The article analyzes the interaction between monetary and fiscal policy in Mexico. We calibrated a semi-structural model for a small open economy, based on Aguilar and Ramírez-Bulos (2018), for Mexico by using quarterly data from 2001Q1 to 2019Q4. The fiscal policy block models the fiscal deficit depending on output, an endogenous sovereign risk premium, a state-owned oil company, and public debt dynamics with domestic and foreign components. We assumed a fiscal rule whereby the deficit has an upper bound. The monetary policy follows a Taylor rule. We study the effects of different shocks on the economy, such as a drop in commodity prices, an expansion of public spending, an increase in the risk premium, a hike in the interest rate, and depreciation of the real exchange rate. We show that, remarkably, the risk premium channel transmits threats from the fiscal block to the monetary block, calling for the central bank to stabilize inflation. By contrast, starting at the economy’s steady state, an exogenous monetary policy shock affects the fiscal block mainly through the interest rate’s influence on the debt service, prompting a fiscal response to stabilize deficit.

Suggested Citation

  • André, Marine C. & Armijo, Alberto & Espidio, Sebastián Medina & Sandoval, Jamel, 2023. "Policy mix in a small open emerging economy with commodity prices," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 4(1).
  • Handle: RePEc:eee:lajcba:v:4:y:2023:i:1:s2666143822000369
    DOI: 10.1016/j.latcb.2022.100082
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    More about this item

    Keywords

    Small open economy; Emerging economy; Policy mix; Commodity prices; Risk premium;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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