Does Money matter? Evidence from Vector Error-correction for Mexico

Following Friedman and Meiselman (1963), the role of money supply in determining income and output has been extensively studied both in the context of developed and developing economies. This paper tests the money-output relationship for Mexico. Drawing on the latest development in time series and cointegration analysis, we estimate a multivariate error-correction model (VECM). Results seem to indicate a unidirectional causation from money to output, implying monetary policy effectiveness. A variety of diagnostic tests are employed, which indicate these results to be quite robust. The results seem to be consistent with the theoretical prediction because Mexico has gradually moved away from a regime of fixed to a flexible exchange rate over this period.