Inflation, money, and real GDP in Mexico: a causality analysis

Abstract

The relation between inflation, M1 money, and real GDP in Mexico is examined using annual data from 1944 to 1991. When investigating the relation between changes in inflation and real GDP growth it is found that it is important to separate the changes in inflation into predictable and unpredictable components. Predictable increases in differenced inflation are found to have a significant, negative effect on real GDP growth. Unpredictable increases in differenced inflation are found to have a significant, positive effect on real GDP growth. In contrast, changes in M1 growth fail to Granger-cause real GDP growth even when the changes in money growth are divided into predictable and unpredictable components.

Notes

¹ In 1993, Mexico introduced a new currency (the ‘new’ peso). Anecdotal evidence suggests that this caused significant and extended pricing confusion. The study ends in 1991 to avoid contaminating the empirical results with any effects arising from this change.

² During this time a number of significant events affected the banking industry, including bank nationalization. A brief review can be found in Wallace (1999). Moderate inflation was also a chronic problem that became critical in the 1980s with annual rates in excess of 100% some years.

³ Mexican data were obtained from INEGI (1994) and Alzati (1997).

⁴ Additional variables, such as growth rates of a real oil price index, US real GDP, and the nominal exchange rate were not significant in final estimates of the real growth equation.