Monetary Policy and the Propagation of Shocks Under Imperfect Exchange-Rate Pass-Through

Abstract

When the Mexican Crisis of 1994 occurred, the Central Bank of Mexico was forced to abandon its fixed exchange rate sys-tem. Since then, monetary policy has been moving toward an inflation targeting regime, which finally became the op-erational monetary framework in 2001. Moreover, Calvo and Reinhart (2000) find evidence that the actions taken by the Mexican central bank seem to exhibit a fear of floating, which is a modern variant of managed floating. In addition, Ball and Reyes (2003) argue that the while inflation has been the num-ber one policy issue for the Mexican central bank, at times this has required occasional intervention to offset inflationary exchange-rate shocks. However, in a low pass-through envi-ronment, the policymaker can simultaneously strictly target consumer price inflation (CPI), but still allow high volatility in the nominal exchange rate to stabilize the real economy in face of the shocks. This result emerges because the low-pass-through eliminates the trade-off between output volatility and inflation volatility. In México in the last years the elasticity of the exchange rate pass-through to general consumer prices has been very low.