Background:

Recently, monetary aggregates have played a minor role in the deliberations of monetary policy in most central banks. This is because the models used are focused on deviations of inflation from a steady state level exogenously given. The quantity of money in the economy determines the price level in the long-run, but does not necessarily influence the deviations from that level. Therefore, monetary aggregates have lost importance in the short-run analysis.

Methods:

An extensive econometric analysis of the long-run money demand is carried out for Mexico using the monetary aggregate M1. The demand for M1 monetary aggregate is estimated by an autoregressive distributed lag model, with quarterly data for Mexico for the period 2001-2014. The model is assessed with a variety of specification and diagnostics tests, furthermore, a thorough analysis of the stability of the parameters is performed. Based on such a demand two indicators of inflationary pressures are calculated: money gap and m* indicator.

Results:

This article illustrates how to use monetary aggregates as indicators of inflationary pressures. This is possible since there is a long-run relationship between such aggregates and prices. Specifically, two indicators are obtained. On the one hand, the money gap, which measures deviations of real M1 from its relationship with its long-run determinants. On the other, the m* indicator is based on the estimation of the price index that is congruent with the quantity of M1 in the economy, once it is adjusted for the long-run trend of its determinants considering its long-run coefficients. Thus, with respect to the long-run inflation trend, the m* indicator suggests that the money growth during the inflation targeting regime was consistent with an important disinflation effort, and then converge to an approximate 3 percent growth; i. e., towards inflationary conditions consistent with the inflation target.

Conclusions:

Monetary policy has been congruent with the inflation target of Banco de México.