Global supply chain inflationary pressures and monetary policy in Mexico

Abstract

In this paper, we examine the impact of stress in the global supply chains on inflation and monetary policy in Mexico, a representative emerging market economy. Using non-linear local projections, we estimate the degree of monetary policy tightening required in a high-stress supply chain environment and compare it to that in a low-stress environment. We instrument the monetary policy shocks with shocks to the federal funds rate. Results suggest that in a high-stress regime, the effect of an increase in the monetary policy interest rate on inflation over a one-year period is reduced considerably. We argue that this reduction is due to the slow response of inflation expectations to a monetary policy tightening in a high-stress regime. Furthermore, raising the interest rate has an effect on producer price inflation, a channel that is absent in a low-stress regime. This finding highlights the role of monetary policy in stabilizing inflation when facing supply shocks that are not necessarily permanent.