Fiscal Constraints on Monetary Policy: the case of Mexico

Abstract

This study examines the impact of public debt on inflation expectations in Mexico, where inflation has persistently exceeded the 3% target despite adequate management of monetary policy. By using public debt surprises as an instrumental variable, we identify exogenous shocks and estimate their effects on short and medium-to-long term inflation expectations through local projections. Our findings indicate that public debt shocks de-anchor inflation expectations, with a more immediate impact on longer-term expectations and a stronger impact on shorter-term expectations. The study highlights the need for sustainable fiscal policies and their crucial role in supporting the inflation-targeting efforts of the central bank.