OUTPUT, INFLATION, AND STABILIZATION IN A SMALL OPEN-ECONOMY - EVIDENCE FROM MEXICO

We study the sources of fluctuation in output and inflation for Mexico, considering fiscal, real, money growth, exchange rate, and asset market disturbances, which are identified using an estimable equilibrium model incorporating important features of high-inflation economies. Changes in inflation are influenced by all shocks, while output growth is explained by real, fiscal, and asset shocks. The results lend strong support to the fiscal view of inflation, and to a lesser degree support the balance of payments view. We also find that higher inflation and higher budget deficits cause each other to spiral upward.