Monetary Policy and Real Currency Appreciation: A BEER Model for the Mexican Peso

A notable feature of the Mexican economy since the late 1980s was the persistent real appreciation of the peso. The appreciation - a key development that helps to explain Mexico's slow rate of economic growth - took place despite changes in the exchange-rate regime, yet with an unchanging focus of monetary policy on gradually reducing the inflation rate. Thus, the frequent assumption that only real-side variables (as opposed to monetary ones) have a lasting or 'long-run' effect on the real exchange may not suit the recent Mexican case. The paper presents the results of an econometric study of exchange rate determination in Mexico for the period 1990Q1-2006Q4. The study is based on the so-called BEER (Behavioral Equilibrium Exchange Rate) model, which relies on Johansen's cointegration methodology and jointly considers real-side and monetary determinants. The estimation results - in the form of two- and three-equation cointegration models - show that, controlling for the influence of real-side determinants, the peso-dollar interest differential had a statistically and economically significant long-run effect on the peso's real exchange rate.Real currency appreciation, real exchange rate, monetary policy, Mexican peso, BEER model, Johansen's cointegration methodology,