Relationship between inflation and economic growth in Mexico
Introduction
Most countries in the world have policies that seek to maintain controlled inflation and Mexico is no exception. Since 2002 the Central Bank of Mexico has aimed to maintain an inflation rate of 3% more, except 1. And it is that high inflation is normally % has no effect on economic growth or that can even have a positive effect. In this document we will try to find the correlation that exists between both variables and thus analyze whether to maintain controlled inflation can somehow affect the economic growth of Mexico. For this we will take data from the World Bank to compare some macroeconomic data and see in a graphic way the difference between the variables in question.
Hypothesis: Maintaining an inflation goal at 3% could cause a slowdown in economic growth in Mexico.
Background
After World War II various empirical studies have tried to interpret the type of relationship between inflation and economic growth. The variety of approaches and criteria show different results that range from those in which it is suggested that inflation influence growth, those who propose a negative relationship between both variables and those that propose a non -linear association between them. Next, the different perspectives and theories raised through the historical behavior of inflation and the implications it have on economic growth are presented.
- Theories that postulate a positive relationship between inflation and economic growth
Among the authors who suggest a positive relationship between inflation and growth is Mundell (1963), who structures a mechanism by relating both variables, separating excess demand for basic products. This mechanism is different from excess demand as a promoter of economic growth: capital accumulation. The Mundell model states that inflation immediately reduces the wealth of people, and consequently they are forced to increase their savings. This increase in savings reduces real interest rates and encourages capital accumulation, accelerating the growth rate of the economy. Therefore, inflation leads to a greater growth in production, since it indirectly increases the savings levels of the economy and capital accumulation.
Tobin (1965) demonstrates the positive effect of inflation on capital accumulation, which led to the economy towards a steady state with a higher level of capital per person, further developing the Mundell model and using the growth model Neoclassical (Solow, 1956; Swan, 1956). The Tobin effect states that inflation causes people to replace money with assets that generate interest, thus obtaining a greater magnitude of capital and promoting economic growth.
For Sidrauski (1967) an increase in inflation does not affect capital accumulation in the stationary state, so economic growth and production level do not present any alteration. In this model, the term money superneutrity is used, which is supported when the real variables are independent of the long -term monetary supply rate.
- Theories that postulate a negative relationship
Stockman (1981) raised a model in which an increase in inflation decreases the acquisition of consumer and capital goods, which entails a lower level of production. In this model, money is a complement to capital, which means a negative relationship between production and inflation rate.
Cooley and Hansen (1989) identify the implications for the accumulation of capital in a basic work-ocio mechanism developed by Greenwood and Huffman (1987). They discover that when the level of employment decreases due to an increase in inflation, capital’s yield, capital amounts and stationary production also decrease. Obtaining as a main result the fact that the level of production falls permanently as the inflation rate increases.
- Theories that raise a non -linear relationship
Some authors focused on which inflation level is detrimental to growth, raising the existence of a relationship between these variables where increases and decreases did not occur with the same intensity, that is, a non -linear relationship. Sarel (1996) analyzes the possibility of nonlinear effects on growth, finding evidence of a significant structural breakup, which occurs when the inflation rate is 8%. Above that inflation rate the estimated effect on growth is significantly negative, while under that rate no effect on growth is generated, even presenting a slightly positive effect. Thus suggesting inflation below the structural rupture.
Ghosh and Phillips (1998) argue that there is a negative relationship between statistically significant inflation and growth. His intention was not to develop an explanatory model of GDP growth, but rather determine the inflation-star correlation, finding that at low inflation rates (2-3% per year or less) the variables are positively correlated, otherwise the Correlation is negative, in addition to discovering a threshold of 2.5% and a significant negative impact above this level. The authors’ policy message suggests that lowering moderate inflation rates can generate gains growth to 0 0.8-0.9 percentage points.
Khan and Senhadji (2001) studied the inflation-separate relationship for industrialized and developing countries estimating the existence of a threshold effect and using new economic techniques. The results in this study pose the existence of a lower threshold for industrialized countries than for developing countries (1-3% and 11-12% respectively). Inflation levels above the estimated threshold produce a significant negative effect on growth, while the levels below the threshold do not generate any effect, so for sustainable growth, low inflation was recommended.
Monetary Policy of the Bank of Mexico
According to De León (2001) in recent years, most central banks have accepted that the greatest contribution to economic development lies in the dejection of inflation. Central banks can use monetary policy instruments to exercise this contribution, however, monetary policy does not act directly on inflation, given that these monetary policy decisions seek to modify the expectations of economic agents, interest rates and the exchange rate. This causes the so -called monetary policy transmission mechanism; in which an incidence on aggregate demand is presented, which, together, determines the future behavior of inflation.
A central bank can influence its actions, goals and instruments in price stability, however, there are factors that leave their control but that can have an important impact on prices, among which are the fiscal policy of the federal government and offer shocks. Although, these factors are outside its scope, the Central Bank must follow them to provide any situation that represents inflationary pressures and act accordingly using their faculties.
Following the exchange and financial crisis of 1994-1995, the monetary policy of the Bank of Mexico has been modified several times with the purpose of making it more effective and transparent, resulting in a gradual evolution towards a monetary policy scheme known as objectives of inflation, whose main purpose is to achieve the stability of general prices. The Central Bank must be autonomous to be able to take the monetary policies that it creates relevant, as well as publicize the medium -term inflation objectives. This autonomy facilitates the Central Bank to act as a counterweight of the public administration, in terms of inflationary situations
Since 2002, the Bank of Mexico has the objective of achieving an annual inflation of 3% that can move within a ± 1% interval. This inflation target gives sufficient margin of manipulation of monetary policy in case a considerable decrease in the interest rate was required.
The Bank of Mexico cannot directly influence the prices of all the goods and services of the economy, so, to fulfill its objective, it seeks economic variables (such as interest rates) on which it can directly influence. In order to fulfill its functions, the Central Bank is the only one that can create or destroy money or monetary base. In this sense, the Central Bank is the only institution that can cover the missing ones or withdraw the liquidity leftovers. In the same way to maintain low inflation, the central bank decides to raise the interest rate seeking to make savings more attractive. As a consequence of this act, families will decide to consume less and save more, which translates into less demand for goods and services and therefore lower prices, so inflation will begin to descend.
Inflation and economic growth in Mexico
Before the Central Bank will use a restrictive monetary policy, the inflation rate was very volatile, even reaching a rate of more than 120% in 1987 and presenting a rate less than 5% in 1994. It was not until 2002 when inflation began to be stable in a range of 3% ± 1 thanks to an increase in the interest rate, thus achieving the goals of the Central Bank.
In our hypothesis we suggest that having an inflation of approximately 3% could be an economic slowdown, however graphs 3 and 4 show us that although there is a relationship between both variables, it does not mean that there is a causality, since the dispersion points In the graphs, both from the period from 1980 to 2000 and from 2001 to 2018, they are far from the line of trend, which means that there is no relevant relationship between how to argue that a variable is cause or consequence of the other. In graph number 2 we can observe the relationship between economic growth and inflation rate. Between 1982 and 1990 inflation was significantly high and there was little economic growth, as proposed by Sarel (1996); Having inflation above 8% economic growth will be harmed, and being less than 8% there may not be a slightly positive relationship, as we can see in the years after 2002 where the inflation rate is low And economic growth was slightly Mayos that in previous periods.
conclusion
Although there is some correlation between both variables, there must not necessarily be causality, therefore, when trying to maintain controlled inflation, the Bank of Mexico may not be affecting the economic growth of the country.
Bibliographic references
- Bank of Mexico. (2010). Monetary policy and inflation. Retrieved in August.
- world Bank. (s.F.). Retrieved in November. Available at: https: // data.world Bank.org/
- from León, to. D., & Greenham, L. (2001). Monetary policy and interest rates: recent experience for the case of Mexico. Mexican Economy New Time, 10 (2), 213-258.
- [Bookmark: _gjdgxs] Fernández, and. A. (2006). Inflation and economic growth in Mexico: a non -linear relationship. Mexican economy. New Time, 15 (2), 199-249.
- Gokal, v., & Hanif, S. (2004). Relationship Between Inflation and Economic Growth. Economics Department, Reserve Bank of Fiji.
- Martínez, l., Sánchez, o., & Werner, A. (2001). Considerations on the conduction of monetary policy and the transmission mechanism in Mexico. Research Document, 2.
- Orlik, n. L. (2014). Monetary policy and economic growth: the reference interest rate of the Bank of Mexico. Economy Informa, 387, 21-42.
- Schwartz, m. J., & López, to. P. (2000). Economic growth and inflation: the case of Mexico. Mexican economy. New time, 9 (2), 165-189.
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