10.1.1.180.2007

10.1.1.180.2007 - MV Y =P t+ IMF Staff Papers Vol. 48, No....

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Can Currency Demand Be Stable Under a Financial Crisis? The Case of Mexico MAY KHAMIS and ALFREDO M. LEONE * The paper finds strong evidence that real currency demand in Mexico remained stable throughout and after the financial crisis in Mexico. Cointegration anal- ysis using the Johansen-Juselius technique indicates a strong cointegration relationship between real currency balances, real private consumption expen- ditures, and the interest rate. The dynamic model for real currency demand exhibits significant parameter constancy even after the financial crisis as indi- cated by a number of statistical tests. The paper concludes that the significant reduction in real currency demand under the financial crisis in Mexico could be appropriately explained by the change in the variables that historically explained the demand for real cash balances in Mexico. This result supports the Bank of Mexico’s use of a reserve money program to implement monetary policy under the financial crisis. [JEL E41, C51, C52] A t the onset of the financial crisis in Mexico and the devaluation of the peso in December 1994, the Bank of Mexico (BOM) was prompted to adopt a floating exchange rate. 1 This had significant implications for the implementation 344 IMF Staff Papers Vol. 48, No. 2 © 2001 International Monetary Fund MV PY = s t + 1 PPS * PV Q X () y p ( β ) i S Y i , SP P ε +> Es tt EPVQ X =+ Fi ** LY i Y ,, εε * May Khamis is an Economist in the Monetary and Exchange Affairs Department of the IMF. Alfredo Leone is Assistant Director of the Monetary and Exchange Affairs Department of the IMF. The authors would like to thank Philipp Rother, Kevin Ross, Hyginus Leon, and Eduardo Levy-Yeyati for very useful comments and discussions. The authors are also grateful to the Bank of Mexico, Paul Hilbers, Daniel Dueñas, Gabriel Sensenbrenner, Karl Driessen, Angel Ubide, Rogelio Morales, and Mario Mesquita for their comments, as well as Claudia Echeverría for helpful research assistance and Natalie Baumer for editorial comments. The usual disclaimer applies. 1 Prior to the devaluation of the peso, the exchange rate was allowed to fluctuate within a band.
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CAN CURRENCY DEMAND BE STABLE UNDER A FINANCIAL CRISIS? 345 of monetary policy where the exchange rate no longer could provide the nominal anchor for the economy. Consistent with its target for price stability, the BOM established a reserve money target (and, in particular, a limit on the annual growth of its credit) as a central element of its monetary program. 2 The annual target for reserve money was formulated by projecting the demand for reserve money (currency plus banks’current accounts at the central bank), taking into account the inflation target. 3 Since the established reserve money target is based on projec- tions of the demand for reserve money using the historic relationship governing the demand for reserve money, underlying the adoption of a reserve money target is an assumption that the relationship governing the demand for reserve money (and thus currency) remained stable during the financial crisis.
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This note was uploaded on 02/13/2012 for the course ECON 101 taught by Professor Malrani during the Spring '05 term at Bunker Hill.

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10.1.1.180.2007 - MV Y =P t+ IMF Staff Papers Vol. 48, No....

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