North American Journal of Economics and Finance 24 (2013) 101–112

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North American Journal of

Economics and Finance

Crucial exchange rate parity. Evidence for Mexico

Eduardo Loría ∗, Emmanuel Salas
National Autonomus University of Mexico, Mexico

a r t i c l e i n f o a b s t r a c t

Article history: Through a structural vector error correction model, one restricted
Received 16 April 2012 cointegrating relationship for monthly data (1999.01–2012.04) was
Received in revised form 11 July 2012 found between three exchange parities of great relevance for the
Accepted 12 July 2012
Mexican economy: US Dollar–Euro, Mexican Peso–US Dollar, and
Mexican Peso–Euro. The data’s structure revealed endogeneity of
JEL classification: the last one, but the first is the one that adjusts the long run (coin-
C22
tegrating) relation. A unitary elasticity of MxP–Euro parity to the
E27
other two parities was found, which validates PPP condition in
F31
absolute terms. These results are crucial to analyze the possible
Keywords: long run exchange effects on the Mexican real and financial vari-
PPP ables because of the possible intensification of the Euro crisis and
Exchange rate the currency war.
Cointegration
© 2012 Elsevier Inc. All rights reserved.
Structural restrictions
SVEC

“If all currencies are moving up or down together, the question is: relative to what? Gold is the
canary in the coal mine. It signals problems with respect to currency markets. Central banks
should pay attention to it.”
Alan Greenspan

1. Introduction

Mexico has had a very dynamic incorporation to the globalization process since the mid 1980s,
specifically when it began to open and direct its trade and finance mainly to the United States. As an

∗ Corresponding author at: Facultad de Economia, Circuito Interior s/n, Ciudad Universitaria, México, D.F. C.P. 04510
Mexico/National Autonomous University of Mexico, School of Economics (UNAM-DEP FE), CEMPE, Mexico.
Tel.: +52 55 5622 21 42; fax: +52 722 27418 88.
E-mail addresses: eduardol@unam.mx (E. Loría), salas.emmanuel@gmail.com (E. Salas).

1062-9408/$ – see front matter © 2012 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.najef.2012.07.001
102 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

important point of this process, the country also entered into a new path of industrialization by inte-
grating its industry to the US manufacturing industry through the maquila (in-bond plants). Afterward,
the North American Free Trade Agreement1 was a kind of formal consolidation of this new growth
strategy.
For this reason, most theoretical and empirical works are focused in the bilateral exchange
rate determination and its implications to the US economy. Several works have proved that
trade and business cycle have been synchronized since the late 1980s (Chiquiar & Ramos, 2005;
Cuevas, Messmacher, & Werner, 2003; Mejía & Campos, 2011). Nevertheless, the increasing eco-
nomic importance in the last decades of the European Union (EU)––although a minor one––to
the Mexican economy is something worth mentioning. Since the late 1990s, the formation
of the EU has progressively impacted all countries, and Mexico has not been the excep-
tion.
Regarding the relative and systematic weakness of the US Dollar until mid 2007, the Euro began
to be considered as an alternative international reserve currency (Menzie & Frankel, 2005); however,
because of the great depression in 2008–2009––and the default possibilities in some EU countries,
this option has vanished.2
Thus, it is plausible to consider that in spite of the huge economic and social imbalances in the
United States, the dollar will still be the most important international reserve currency, as well as the
worldwide convertible currency. However, that does not mean that the volatility among exchange
rates has ended nor it can be neglected.
The empirical analysis of the long run relation between these three currencies is crucially important
to assess the impacts and the transmission mechanisms that the current worldwide economic crisis
has had so far and might have in the future on the Mexican economy through modifications in exchange
world parities. Furthermore, it is relevant in views of the tumultuous international scene that for years
has suffered from huge volatility (basically since mid-2008), impacting all exchange rates and affecting
financial and real variables. Therefore, the main interest herein is to quantify the long run relationship
of the Mexican Peso (MxP) with other two strong currencies, the US Dollar (USD) and the Euro (E) for
1999.1–2012.4, more specifically, to prove that PPP in absolute terms holds for the MxP, which can be
attributed to a good (efficiency) arbitrage performance. Therefore, it is possible to argue that changes
in nominal exchange rates reflect the changes in relative prices in the three economies involved. The
present study takes an important step forward in literature because it considers three parities at once
and not only the customary two (bilateral).
Through a structural vector error correction model (SVEC), one restricted and unitary elastic
cointegrating relationship (1999.01–2012.04) was found between three exchange parities of great
relevance to the Mexican economy: USD–E, MxP–USD, and MxP–E. The data’s structure revealed
endogeneity in the last one, but the first is the one that in the short run adjusts the long run
(cointegrating) relation. A unitary elasticity of MxP–Euro parity to the other two parities also was
found.
The reminder of this article is organized as follows: Section 2 provides an overview of prior applied
research on PPP for Mexico. Section 3 deals with theoretical issues regarding exchange parities in
the long run, based on the PPP approach and develops the framework for the model to be estimated.
Customarily, only two parities are analyzed to prove PPP; hence, the main contribution of this paper
is discussed here. Section 4 develops the econometric approach in which the SVEC methodology is
described.3 Section 5 discusses and analyzes the main econometric findings. The paper ends with a
conclusion and by pointing out some further insights.

1
Officially started on January 1, 1994.
2
In effect, despite the financial weakness in the United States, the dollar has strengthened up, and the feasibility of the euro
is now in doubt because of the PIGS’s crisis and the corresponding adjustment policies that have been applied, as well as those
that will have to be implemented in the years to come.
3
Despite that the euro became the official currency in circulation in the EU in January 2002, it was possible to find information
back to 1999.1 due to the fact that it was a virtual currency, and therefore the estimation was monthly for the period 1999.01-
2012.04. So here the whole period will be considered as the long run.
 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112 103

2. Literature review

In this section, empirical works in favor of PPP for Mexico are presented. Atrayee and Van De Berg
(1996), by using cointegration, confirm PPP during the period 1920–1994 and find that deviations from
PPP were corrected within an average of four years. This finding underscores the futility of Mexican
policies by attempting to manage (maintain overvalued) its currency (peso) as an inflation anchor.
McNown and Wallace (1989) also find that PPP holds for some high inflation Latin American
countries (1970s and 1980s) including Mexico. Alba and Papell (2007) also prove that PPP holds for
Latin American countries through panel data tests.
Kakkar (2001) finds that for 1955–1996, the Mexican-US bilateral real exchange is cointegrated
with the Mexican and US relative price of non-tradable goods; thus, any gap between the actual real
exchange rate and its estimated equilibrium value will eventually be reversed. Therefore, permanent
changes in the inflation in the non-tradable goods can account for the permanent changes in Mexico’s
real exchange rate.
Robertson, Kumar, and Dutkowsky (2009) estimate several panel data models to examine data
aggregation bias in testing long run PPP between the US and Mexico. Estimates with disaggregated
data and heterogeneous coefficient estimators offer strong evidence of PPP.
Loría, Sánchez, and Salgado (2010) provide empirical evidence supporting the validity of both short
and long run versions of the Monetary Approach of Exchange Rate determination for the Mexican
Peso–US Dollar rate for 1994–2007 using a cointegrated SVAR model. This work implicitly accepts PPP
and the law of one price.
Varella (2007) finds favorable evidence on half-life (persistence measure) PPP hypothesis for
Mexico, in the sense that it takes the Mexican Peso 1–3 years for a unit shock to dissipate––by one
half. This span period contrasts with Rogoff (1996: 648) who states that “consensus estimates for the
rate at which PPP deviations damp (. . .) suggests a half-life of three to five years. . .”
A number of microeconomic and regional oriented works have found evidence in favor of PPP. For
example, Fullerton, Fierro, and Villalobos (2009), Blanco-González and Fullerton (2006), and Fullerton
and Coronado (2001) have detected several efforts in proving the law of one price at a microeconomic
level. By analyzing restaurant pricing at the border flex sister cities of El Paso, Texas and Ciudad
Juárez, Chihuahua, they found that menu item price ratios are strongly correlated with the peso-dollar
exchange rates. Specifically, in Fullerton et al. (2009: 287), they found that “several factors indicate that
periodic deviations from the law of one price can plausibly occur, but that regional and international
pricing patterns tend to eventually adjust to levels in line with exchange rates.” In support of these
findings, Blanco-González and Fullerton, and Coronado (2009: 32) claim that arbitrage helps equalize
cross-border (restaurant) prices.

3. Theoretical issues

The absolute purchasing power parity (APPP) theory states that in the long run, the nominal
exchange rate between two currencies shall be equal to the ratio of their aggregate prices, such that
one monetary unit of a country shall have the same purchasing power in the other one. In this curse,
arbitrage plays a major role (Rogoff, 1996).
This approach has been useful in explaining several historical periods. For example, the period
between world wars and the first years after the breakdown of the Bretton Woods era (Taylor &
Taylor, 2004). Another important feature to this approach is that in the long run, the parities also
depend on the economic linkage between countries, such as foreign trade and capital flows, although
it is accepted that the volatility of the latter and the growth differences in money supply may cause
exchange fluctuations in the short run.4 For Campa and Goldberg (2002) in the OECD countries, the
most important determinants in the exchange rate are of a microeconomic nature, and they refer to
the countries’ imports, basket of goods and services.

4
The portfolio approach as well as the monetary approach of the exchange rate has become important in explaining the
exchange volatility in the short run.
104 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

Behind the PPP hypothesis lays the version of the law of one price, which states that ultimately,
the nominal exchange parity of two countries must equalize their relative prices:
Pj
e(j,i) = (1)
Pi
which “ensures that the purchasing power in term of goods for each currency is the same regardless
of where someone uses the currency to buy goods” (Barro, 2001: 600). Similarly, if PPP holds in the
long run, then the real exchange rate is predicted to be a stationary and mean-reverting process.
Before starting the econometric analysis, it is important to specify the model to be estimated. Based
on Eq. (1), the nominal exchange parity between the MxP–USD (eMxP USD ) can be defined as follows:

eMxP USD ∗ PUS = A1 ∗ PMx (2)

where PUS and PMx are the aggregate prices of the United States and Mexico. According to Patterson
(2000: 555), this expression claims that if APPP applies A1 = 1 and, therefore, is a representation of the
real exchange rate MxP–USD. Rearranging terms and multiplying the right hand side by PEU /PEU :

eMxP USD = A1 ∗ PMx /PUS ∗ PEU /PEU (3)

eMxP USD = A1 ∗ PMx /PEU ∗ PEU /PUS (4)

Now, the respective arbitrage condition appears for the two relative prices:

eMxP USD = A1 ∗ [A2 PMx /PEU ∗ A3 PEU /PUS ] (5)

The main hypothesis to be tested in the following section is that A1 = A2 = A3 = 1. In this respect,
Obstfeld and Rogoff (1997: 202) state that “the theory of PPP predicts that real exchange rate should
be equal 1, or at least have a tendency to return quickly to 1 when that long run ratio is disturbed for
some reason.” Therefore, the Ai terms are eliminated, which function as real exchange rates. Another
hard reason to assume Ai is 1 is based on the market arbitrage. The market movements equal the profit
caused by a depreciation risk, then resulting that the relative nominal exchange rates clearly show the
relative price levels.

eMxP USD = PMx /PEU ∗ PEU /PUS (6)

By the assumption in (1), the relative parity eMxP USD can be expressed by the relative prices and vice
versa, thus Eq. (6) becomes:

eMxP USD = eMxP EU ∗ eEU USD (7)

This last equation expresses the relationship between three relative nominal exchange parities. By the
empirical hypothesis to be tested shortly, the endogenous variable is eMxP EU ; thus, and by expressing
the inverse of the nominal exchange rate between E and USD, we obtain:

eMxP EU = eMxP USD ∗ eUSD EU (8)

Finally, and by applying logs, a final expression in terms of elasticities is derived, which is very handy
for economic as well as for econometric purposes:

εMxP EU = εMxP USD + εUSD EU (9)

This is the model to be estimated in the next section.

4. Econometric issues

Before proceeding to the econometric analysis, it is convenient to briefly analyze the historical
evolution of these three exchange parities. Fig. 1 allows us to make the monthly follow-up. In general
terms, there are upward trends (secular depreciation) for MxP and the USD regarding the E as well as
a huge depreciation of both during the last quarter in 2008. Nevertheless, it is important to mention
the long stability of the MxP–USD until 2008. Another stylized fact has to do with the recovery of both
currencies related to the E after 2009, just when the crisis in some EU countries began.
 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112 105

Table 1A
Unit root test.

Aumented Dickey Fuller Phillips Perron

5% level t-Statistic Prob. 5% level t-Statistic Prob.

Ho: Log eUSD E has a unit root

Trend and intercept −3.4385 −2.5476 0.3051 −3.4383 −2.4179 0.3689
Intercept −2.8797 −1.2804 0.6380 −2.8796 −1.0676 0.7278
None −1.9428 −0.6126 0.4506 −1.9428 −0.4817 0.5058

Ho: D(Log eUSD E ) has a unit root

Trend and intercept −3.4387 −8.5610 0.0000 −3.4385 −8.7478 0.0000
Intercept −2.8798 −8.5930 0.0000 −2.8797 −8.7779 0.0000
None −2.5796 −8.9272 0.0000 −1.9428 −8.7982 0.0000

Ho: Log eMxP E has a unit root

Trend and intercept −3.4385 −3.4961 0.0432 −3.4383 −2.4699 0.3426
Intercept −2.8797 −1.3573 0.6018 −2.879 −0.5153 0.8839
None −1.9428 0.7107 0.8677 −1.9428 0.8302 0.8896

Ho: D(Log eMxP E ) has a unit root

Trend and intercept −3.4385 −9.0941 0.0000 −3.4385 −9.6163 0.0000
Intercept −2.8797 −9.1111 0.0000 −2.8797 −9.6329 0.0000
None −1.9428 −9.0912 0.0000 −1.9428 −9.6535 0.0000

Ho: Log eMxP USD has a unit root

Trend and intercept −3.4385 −3.4961 0.0432 −3.4383 −3.2156 0.0851
Intercept −2.8797 −1.3573 0.6018 −2.8796 −1.1635 0.6894
None −1.9428 0.7107 0.8677 −1.9428 0.71212 0.8680

Ho: D(Log eMxP USD ) has a unit root

Trend and intercept −3.4385 −9.0941 0.0000 −3.4385 −9.1057 0.0000
Intercept −2.8797 −9.1111 0.0000 −2.8797 −9.1215 0.0000
None −1.9428 −9.0912 0.0000 −1.9428 −9.0912 0.0000

Table 1B
Unit root test Kwiatkowski–Phillips–Schmidt–Shin.

5% level t-Statistic

Ho: Log eUSD E is stationary

Trend and intercept 0.1460 0.1654
Intercept 0.4630 1.208

Ho: D(Log eUSD E ) is stationary

Trend and intercept 0.1460 0.1362
Intercept 0.4630 0.1362

Ho: Log eMxP US is stationary

Trend and intercept 0.1460 0.0575
Intercept 0.4630 1.2687

Ho: D(Log eMxP USD ) is stationary

Trend and intercept 0.1460 0.0379
Intercept 0.4630 0.0539

Ho: Log eMxP E is stationary

Trend and intercept 0.1460 0.1228
Intercept 0.4630 1.3309

Ho: D(Log eMxP E ) is stationary

Trend and intercept 0.1460 0.1553
Intercept 0.4630 0.19012
106 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

Dollar-Euro Peso-Euro
1.6 20

1.4 16

1.2 12

1.0 8

0.8 4
2000 2002 2004 2006 2008 2010 2000 2002 2004 2006 2008 2010

Peso-Dollar
15

14

13

12

11

10

9
2000 2002 2004 2006 2008 2010

Fig. 1. Relative exchange rates.

By virtue that the three relative parities are I(1) (see unit roots tests in Tables 1A and 1B), it is
pertinent to use the Johansen’s (1992) cointegrating procedure, by which we can obtain the long run
relations (elasticities) and the error correction model.
The let the data freely speak approach (Hoover, Johansen, & Juselius, 2008)––by which non-a pri-
ori restrictions are imposed––it was found that the MxP-E relationship shall be considered as the
endogenous.5 This fact and the statistical properties of the data determined the restrictions that
identify the error correction coefficient matrix (˚, see Eq. (11)).
A crucial point consists in finding how many cointegrating relations exist, as well as the structure
of the error correction mechanism. To accomplish it, a marginalization process (Hendry, 1997) was
followed as of the free imposition of restrictions in the adjustment coefficients matrix through the
trial-error technique and not a predetermined approach or theory.
It is convenient to point out that the economic theory usually refers only to long run equilibrium
relationships, leaving the dynamic adjustments to mathematics and to the data structure. According
to the modern time-series approach, it is necessary to deal with not only the long run parameters but
also the short run disequilibria by letting the data freely speak (Hoover et al., 2008; Juselius, 2006;
Lütkepohl & Krätzig, 2004).

5
By the variance decomposition analysis of the SVEC it turned out to be totally dependent on the other two variables. See
Table 8.
 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112 107

Table 2A
Cointegration test for: Log eUSD E Log eMxP USD Log eMxP E .

r0 LR p-Value 90% 95% 99%

0 57.38 0.0000 32.25 35.07 40.78

1 9.08 0.7304 17.98 20.16 24.69
2 1.59 0.8465 7.60 9.14 12.53

Note. Johansen trace test, intercept included; lags (levels): 3.

Table 2B
Cointegration test for: Log eUSD E Log eMxP USD Log eMxP E .

r0 LR p-Value 90% 95% 99%

0 64.71 0.0000 21.76 24.16 29.11

1 8.11 0.2316 10.47 12.26 16.10
2 0.07 0.8469 2.98 4.13 6.93

Note: Saikkonen and Lütkepohl test, intercept included; lags (levels): 3.

This is a specific feature of the SVEC methodology because it allows the data to indicate the
adjustment properties and, therefore, the statistical relation of the series in the short and in the long
run.
The necessary condition for these models to be solved is that at least there is one cointegrating
vector (r = 1), from which it shall be concluded that the range of the system is ˇ = r × k and that Yˇ Yt−1
is a vector of r × 1 lagged disequilibrium terms (Patterson, 2000: 634). The SVEC model is able to
accurately find the short-term adjustment properties in the I(1) cointegrating series.
The Johansen’s general unrestricted VEC form can be expressed in Eq. (10), and by incorporating a
restrictions matrix ˚ of size k × k, it is possible to identify the matrix of error correction terms.

Yt = Yt−1 + ˛ˇYt−1 + t (10)

˚Yt = Yt−1 + ˛ˇYt−1 + t (11)

The number of restrictions imposed on matrix ˚ for the model to be exactly identified is k − 1,
which turned out to be two.
The restrictions included in the ˚ matrix transform the error correction terms contained in matrix
˛ giving a new matrix :

˚−1 ˛ˇ = ˇ (12)

5. Results and discussion

As mentioned before, (9) is the equation to be estimated monthly for 1999.01–2012.04.6

By the Johansen’s trace test and Saikkonen and Lütkepohl cointegration tests (Lütkepohl & Krätzig,
2004, chap. 3), only one cointegrating vector was found (see Tables 2A and 2B).
According to standard criteria7 a restricted VECM(3) was specified, with intercept and a set of
dummies.8

6
All data set is seasonal adjusted and refers to monthly sale average and was taken from http://www.oanda.com/lang/
es/currency/historical-rates/. See Fig. 1.
7
Akaike Info Criterion, Final Prediction Error and Hannan-Quinn Criterion.
8
This set contains the following variables: (a) a pulse dummy for 2000.09 to accomplish for structural change detected by
the Chow test; (b) two more dummies that capture outliers and helps to obtain correct specification of the SVEC. These last
dummies were estimated according to the Chebyshev Theorem (Wakerly, Mendenhall, & Scheaffer, 2002, chap. 3).
108 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

3.0

2.8

2.6

2.4

2.2

2.0
99 00 01 02 03 04 05 06 07 08 09 10 11

Log Mx_Peso
Log MxPeso_US Dollar + Log US Dollar_ Euro

Fig. 2. Mx Euro. Cointegrated relationship. Fitted.

Table 3
Portmanteau test for autocorrelation.

Tested order 4
Test statistic 13.6762
p-Value 0.0906
Adjusted test statistic 13.9396
p-Value 0.0834
Degrees of freedom 8.0000

A restricted two steps cointegrated model was estimated9 and obtained unitary elasticities; how-
ever, to statistically prove it (the unitary elasticity of the two parities regarding MxP–E); two long run
restrictions were imposed this time in the cointegrating vector,10 obtaining the following outcome:

εMxp E = 1.0000 ∗ εUSD E + 1.0000 ∗ εMxp USD + et (13)

(t) (971.293) (685.066)

In Fig. 2 the fit of this cointegrating vector is presented. The estimated restricted VECM is dynami-
cally stable11 and passes all the correct specification tests (see Tables 3–7).
Regarding the short run adjustments embedded in the long run relation, the following joint restric-
tion was applied Ri  i =  21 =  31 = 0, which cannot be rejected. The SVEC threw a  11 of −0.795
(t = −4.379), which applies directly on the eUSD E ; this former result could explain an accounting
fact.
As mentioned before, according to the variance decomposition analysis, the eMxP E parity turned
out to be totally dependent on the other two and by the mathematical derivation of (9) it was defined
as endogenous (see Table 8).

9
1st Johansen approach and 2nd 3SLS. JMulti 4.24. (Lütkepohl and Krätzig, 2004).
10
To be sure that the two parameters are long run unitary elastic, we tested the significance of the following restriction:
b(3,1) = b(2,1) = −b(1,1) = 1, reporting a 2 = 0.0046(0.9458), which means that we cannot reject the null.
11
Modulus of the eigenvalues of the reverse characteristic polynomial: |z| = 1.7028, 1.7028, 2.4405, 1.3403, 1.3403, 2.1812,
2.1812, 2.0475, 2.0475, 2.4192, 1.0000, 1.0000.
 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112 109

Table 4
Tests for nonnormality: Doornik and Hansen.

Joint test statistic 7.0277

p-Value 0.3183
Degrees of freedom 6.0000
Skewness only 6.2713
p-Value 0.0991
Kurtosis only 0.7564
p-Value 0.8599

Table 5
Tests for nonnormality: Lütkepohl.

Joint test statistic 2.3305

p-Value 0.8869
Degrees of freedom 6.0000
Skewness only 0.5813
p-Value 0.9007
Kurtosis only 1.7492
p-Value 0.6261

Table 6
ARCH-LM test with 4 lags.

Variable Test statistic p-Value (2 ) F statistic p-Value (F)

u1 8.9732 0.0618 2.3840 0.0540

u2 4.5878 0.3323 1.1826 0.3209
u3 3.5621 0.4685 0.9119 0.4588

Table 7
Multivariate ARCH-LM test with 4 lags.

VARCHLM test statistic 168.3641

p-Value (2 ) 0.0807
Degrees of freedom 144.0000

Table 8
Variance decomposition for Log eMxP E .

Period Log eUSD E Log eMxP USD Log eMxP E

1 0.67 0.33 0
2 0.73 0.27 0
3 0.69 0.31 0
4 0.68 0.32 0
5 0.67 0.33 0
6 0.66 0.33 0
7 0.66 0.34 0
8 0.66 0.34 0
9 0.66 0.34 0
10 0.66 0.34 0
11 0.66 0.34 0
12 0.66 0.34 0
13 0.66 0.34 0
14 0.66 0.34 0
15 0.66 0.34 0
16 0.66 0.34 0
17 0.66 0.34 0
18 0.66 0.34 0
19 0.66 0.34 0
20 0.66 0.34 0
110 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

Log e USD_E Log e MxP_USD

1.6 16

1.4 14

1.2 12
1.0 6
8 10
4
4 0.8
8
2
0
0
-4 -2
-8 -4
2000 2002 2004 2006 2008 2010 2000 2002 2004 2006 2008 2010

Actuals Scenario 1 Actuals Scenario 1

Deviation Percent Deviation Deviation Percent Deviation

e MxP_E
20

16

12
8
8
4
4
0

-4

-8
2000 2002 2004 2006 2008 2010

Actuals Scenario 1
Deviation Percent Deviation

Fig. 3. SVEC historical simulation.

Both the current and the capital accounts are expressed in dollars, despite that the Mexican econ-
omy has a direct economic exchange in Euros. So there are important transactions in Euros that should
be converted into Dollars to carry out the balance of payments. Therefore, it can be suggested that the
eMxP E transactions are “penalized” by the eUSD E.
Finally, and to prove the consistence of the whole system, the estimated SVEC was now simu-
lated in levels through the Gauss–Seidel algorithm. The good fit of the whole system is noteworthy
(Fig. 3).

6. Conclusion

The econometric results obtained through the cointegrating Johansen (1992) procedure are in line
with the main statement of APPP; that is, in the long run, there are unitary relationships between
three crucial exchange parities for the Mexican economy.
It was found that the long run movements in the eMxP E relationship are affected symmetrically
(unitary elastic) by the eMxP USD and eUSD E parities. However, the short-run disequilibria adjustment
embedded in the cointegrating relation only comes out from eUSD E .
 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112 111

Because of the US and European financial turmoil, the structural adjustment a la IMF and the possi-
bility of default in some euro zone economies, the odds of a weaker Euro in relation to the USD and to
the MxP increase. Therefore, it is plausible to consider that in this case, negative effects on the balance
of payments and in the real sector of the Mexican economy may occur. If this is the case, not only
tourism, but also FDI and some other important capital inflows will be reduced in the years to come.
However, most important are the foreseen negative effects with a decrease in European direct invest-
ment over the Mexican economy through the technological transmission mechanism. Most of the FDI
coming from Europe are biomedical and high technology that could severely depress an important
source of economic growth.
Current events in Europe (slim down fiscal policies in the majority of the EU countries and in the
United States) do not seem positive for the medium and long run in the Mexican economy.

Acknowledgements

Support for this research was provided by PAPIIT IN-305711 DGAPA, UNAM. Helpful comments
and suggestions were provided by two anonymous reviewers. The usual disclaimer applies.

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112 E. Loría, E. Salas / North American Journal of Economics and Finance 24 (2013) 101–112

Eduardo Loría Ph.D., Full time Professor at National Autonomous University of Mexico (UNAM), School of Economics. Author
of several articles and books. Chairperson of the Center of Economic Modeling and Forecasting (CEMPE). Facultad de Economia.
Circuito Interior s/n. Ciudad Universitaria. México, D. F. C. P. 04510, Mexico. Tel.: +55 5622 21 42. Email: eduardol@unam.mx.

M.A. Emmanuel Salas, Professor at National Autonomus University of

Mexico, School of Economics (UNAM-DEP FE), Ph.D. student and Associ-
ated at the CEMPE.