Taylor rule and monetary policy transmission mechanism in a new keynesian economy: evidence for Mexico

This paper estimates two SVAR models to assess Mexican Monetary policy rate for the period 2000-2015, which are recursively identified according to Gali and Monacelli (2005) model. This paper shows that monetary policy rate responds to GDP, inflation and exchange rate as Taylor's Rule predicts. When controlling for General Consumer's Price Index inflation, monetary policy barely affects aggregate demand even if exchange rate appreciates, nevertheless GDP diminish after contractive monetary policy takes place. Inflation rate lightly increases after interest rate rises, which does not coincide with New Keynesian predictions. A second model is estimated controlling for underlying inflation. Its results exhibit more interest rate sensitive consumption and net exports, while real exchange rate and GDP change as New Keynesian model predicts. Inflation decreases after monetary policy rise but its fluctuations are close to zero. According to Gali (2008) such small changes indicate nominal rigidities existence.

Small open economy, new keynesian model, recursive identification, SVAR, underlying inflation

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