Using monthly data to bond and equity markets in Mexico from U.S. investors, we search for responses in the vector autoregressions (VARs) - on the real exchange rate and reserves in Mexico - to shocks in U.S. interest rates and to the Mexican M2/Reserves ratio over the years 1988-2001. The ratio M2/Reserves measures the degree of financial vulnerability and brings this literature closer to theoretical constructions. Shocks to U.S. interest rates explain not more than 7.4% of the variance of international reserves and only 5.5% of real exchange rate changes under conventional specifications. Blending M2/Reserves with real exchange rates at the end of the VAR, external shocks explain 12.5% of the variance of real exchange rate one year after the shock and 12.8% of the variance of M2/Reserves. Typically, the responses in Mexico of U.S. interest rate shocks are as expected: higher shocks to U.S. interest rates move Mexican M2/Reserves up, depreciating the real exchange rate in Mexico.
Varella Mollick, André. 2002. "Effects of U.S. Interest Rates on the Real Exchange Rate in Mexico." Economics Bulletin 6, 1.