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Three Stages of Mexico´s Monetary and Fiscal History : Growth with Low Inflation , Fiscal Expansion and Reforms. Alejandro Hernandez -Delgado, Felipe Meza, and Ignacio Trigueros- Legarreta (ITAM) April 2014 Discussant : Gerardo della Paolera (Universidad de San Andrés) .

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ThreeStages of Mexico´sMonetary and Fiscal History: GrowthwithLowInflation, Fiscal Expansion and Reforms

Alejandro Hernandez-Delgado, Felipe Meza, and Ignacio Trigueros-Legarreta (ITAM)

April 2014

Discussant: Gerardo dellaPaolera

(Universidad de San Andrés)

ThreeStages of Mexico´sMonetary and Fiscal History: GrowthwithLowInflation, Fiscal Expansion, and Reforms
  • Analysis of the monetary and fiscal history of Mexico (circa 1978-2009) through the lenses of Sargent (1992), Kareken and Wallace(1981), Nicolini( 2010) .
  • The authors follow the economics of budget constraints which includes debt denominated in foreign currency and debt indexed to inflation.
  • This is expressed as in Kehoe, Nicolini, Sargent (2013) as:
the economics of budget constraints
TheEconomics of BudgetConstraints
  • Rearranging the «canonical» budget constraint, KNS(2013) obtain equation (1a):
  • The debt triplets are to be explained by the inflation tax, the return on nominal bonds, the return on the indexed bonds, the return on the dollar denominated debt and the primary deficit including transfers.
the economics of budget constraints1
TheEconomics of BudgetConstraints


  • Theauthorsgather data forthe 1978-2009 period to decomposethechanges in publicdebtinto (a) theinflationtax; thereturnonthegovernmentdebt and theprimarydeficit.
definitions and data
Definitions and Data
  • Government: PublicSector + IFDC +IFIBC
  • Data: InitialProblems to assesstheDebt Stock: mix of registration at par and marketvalues. ProxiedforNationalDebt
  • OnlyPublic Sector, usedmarketvalue of debtissuedbynationalgovernment net of debts at Central Bank
computing the foreign debt ratio
Computing theForeignDebt Ratio
  • No statisticsonthemarketvalue of foreigndebt: the 1988 debt stock estimated at 64 billion USD composedbythebankdebt at marketvalues plus non-bankdebt at facevalue.
  • Thentocalculatetheyearly stocks use of theflowsrelatedtoassets and liabilitiesfromthe Capital account.
difficulties to get indexed debt
  • In thepaper, onlya consolidated figure forthe Total Nominal debtcouldbeobtained. The ratioθrisimplicitlyincluded in theNationalDebt Ratio θN.
fig 2 c change in monetary base to gdp and inflation tax revenue as fractions of gdp
Fig. 2(c): Change in Monetary Base to GDP and InflationTaxRevenue (as fractions of GDP)
fig 2 d change in foreign debt ratio and total net i nterest payments as fractions of gdp
Fig. 2(d): Change in ForeignDebt Ratio and Total Net InterestPayments (as fractions of GDP)
  • In Figure 1 (and 6), primary deficits until 1982/3. After 1986 fall in the foreign debt ratio but increase in the nominal debt ratio.
  • In 2(a) through 2(d), the graphs show if the deficit, total interest payments and the inflation tax revenues drive changes in both ratios.
  • In 2(b) the ratio of foreign debt seem to respond strongly to changes in primary deficit; in 2(d) total net interest payments is closely related to the increase in the Foreign Debt ratio.
accounting for total net interest payments
Accountingfor total net interestpayments
  • After calculating the sequences of the debt ratios, the authors compute net interest on the debt:


  • They need to proxy the gross interest rate R and r*: for R the proxy is the yield on the CETE, the interest payments is calculated as a residual from the total.
  • In Figure 4, the interest rate payments on foreign debt is the main source of fluctuations in total interest payments.
analysis of cumulative changes in debt and their driving components1
Analysis of cumulativechanges in debt and theirdrivingcomponents
  • Introduce:
    • A sequence of primary (deficits) surpluses;
    • A sequence of interest payments;
    • The negative of cumulative changes in the money base (reduces borrowing);
    • The negative in cumulative changes in the inflation tax.
  • Results: In 5(a) interest rate payments are the main driving force to increase the level of indebtedness. In 5(b), the surpluses after 1983 the main force to reduce the ratios.
Fig. 5(b): Cumulativechange of Debt Ratios, CumulativePrimaryDeficit, and Negative of CumulativeInflationTaxRevenue
fiscal expansion of 1970s and the debt crisis of 1982
Fiscal Expansion of 1970s and the Debt Crisis of 1982
  • Dynamics lead by sizeable primary deficits (Fig 6); jump in 1981.
  • Banco de Mexico dominated by the government (fiscal dominance).
  • Progressive increase in the level of indebtedness until 1982 (Fig 9), when debt constrained , inflationary scenario.
  • The stylized facts are explained by the SW model: deficits need not be inflationary as long as you can finance them by issuing debt (foreign?), once debt intolerance is present, the Unpleasant “Fiscal” Arithmetics push you to an inflationary scenario.
  • The “repressed” inflation is a short-run equilibrium when running continuous primary deficits.
economic reforms in the 1990s and the 1994 crisis
Economic Reforms in the 1990s and the 1994 Crisis
  • In 1990’s Independence of the Banco de Mexico, goal is to maintain the purchasing power of the peso: limits advances to the Government (Change in Macroeconomic Regime?)
  • However, huge internal political shock in March 1994, Colosio killed. Political Uncertainty; start issues of Tesobonos; sizeable capital outflows by Nov/Dec 1994.
  • Change in the exchange rate regime.
  • Sudden Stop? Substituting for short term borrowing ( with maturities shortening) and the ratio dollar indexed debt to international reserves increasing) but even then in early 1995 Mexico could not roll-over the short term debt.
  • How the facts fit with the model?
economic reforms in the 1990s and the 1994 crisis1
Economic Reforms in the 1990s and the 1994 Crisis
  • Some stylized facts:
    • Debt ratios not at its maximum, however stock of tesobonos net of international reserves equivalent to 30billion USD.
    • Interest rates skyrocketed because the expectations of further devaluations increased and because of tight monetary policy which maybe the agents believed was to become unsustainable (role of the external bail-out to redress those expectations?) due to a potentially explosive burden of the short-term debt. (here there is a SW flavor only that maybe bailout meant degrees of freedom to maintain monetary independence)
    • These dynamics in spite of a contractionary monetary policy and a pro-cyclical fiscal policy. Smax was not attained because of bail-out?
a historical example of deficit dominance debt fiscal deficits and inflation argentina 1885 1893
A HistoricalExample of DeficitDominance: Debt, Fiscal Deficits and Inflation (Argentina 1885-1893)
sustained p rimary deficits from debt finance to fiscal dominance
SustainedPrimaryDeficits: FromDebtFinanceto Fiscal Dominance

“The monetary and fiscal inconsistency became apparent by the end of the

year 1889. The government, already under a debt-ceiling constraint and with

its specie reserves almost depleted, had no choice but to switch from debt

finance to money creation to cover an ongoing budget deficit. For the 1889-

91 period, the accumulated inflation rate (163.7 percent) and the accumulated

depreciation rate (152.7 percent) are closely correlated with the accumulated

counterfactual inflation rate (154.9 percent)”.

sustained primary deficits from debt finance to fiscal dominance
SustainedPrimaryDeficits: FromDebtFinanceto Fiscal Dominance

“Before the curtain fell in 1891, the drama concluded with an economic policy

that had finally exhausted all the available genuine means of finance and heavily

relied on the inflation tax to finance the budget. The inflation tax and currency

substitution interacted in unfortunate ways that exacerbated the fiscal problem.

If there is a high sensitivity of velocity to inflation (a greater propensity for

currency substitution) then this will imply a higher inflation rate for the same

level of deficit, all else equal. Moreover, currency substitution will lower the

base for the inflation tax, requiring an even higher inflation rate to sustain the

same fiscal gap.» l6