Adjusting to economic integration with the United States: Mexico's exchange rate policy and business cycle features since 1980

Mexico is in the middle of a long lasting process of economic integration with its NAFTA partners, especially with the United States. This process started in the 1980s with unilateral trade liberalization and was reinforced in 1994 by the enactment of NAFTA. For more than two decades the Mexican government has adjusted institutions and public policies to achieve economic stability and sustainable economic growth in the new context of globalization and economic integration.In addition to trade liberalization, the Mexican government has implemented successive economic reforms including deregulation of economic activity, privatization of the banking system and state-owned enterprises, restructuring of external debt, and legal reform of rural property. These reforms have contributed to economic stability in the country. However, sustainable economic growth is still to come.In this study we investigate two important issues related to the process of economic integration: Mexico's exchange rate policy and features of the business cycles of Mexico and the United States. Chapter I presents a brief overview of the Mexican economy. Chapter 2 analyzes the role of two different kinds of exchange rate policies (pegged and floating) for the behavior of inflation and economic growth using a vector error correction approach. The main conclusion is that the exchange rate regime does matter for inflation during the 1980--2004 period. With respect to economic growth, however, our findings are not conclusive. Chapter 3 examines the main characteristics of the Mexican and U.S. business cycles and some of their interactions using the classical approach based on second moment statistics as well as modern time series tools. We also investigate the effect of NAFTA on business cycle synchronization in the two countries and the nature of the long-run relationship among them. Our findings indicate that Mexican and U.S. gross domestic products have shared a long-run equilibrium relationship since 1980, with the U.S. driving the Mexican business cycle. It is also clear that the Mexican economy has strengthened its ties with the U.S. economic activity since the enactment of NAFTA. Chapter 4 presents some concluding remarks and suggests some pending tasks for Mexico's economic policy.