Supply and Demand Shocks in Mexico

I use the Blanchard & Quah (1989) decomposition to identify the permanent and transitory components of Mexican GDP and unemployment rates between 1985 and 2011. The main findings of this exercise are: (1) the transitory, or so called “demand shocks”, explain the majority of fluctuations in unemployment, and (2) the permanent, or so called “supply shocks”, explain the majority of fluctuations in GDP. The first finding corresponds closely to the conventional viewpoint that unemployment in Mexico is structural, while the second finding corresponds to the idea that negative fluctuations in production are caused by severe economic crises that impact the long-run performance of the Mexican economy. I use these results to make two policy recommendations: (1) trade, fiscal, and monetary policy must be designed to generate financial stability, and (2) changes in labor legislation must be made in order to reduce unemployment permanently.