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Group 10

MEXICAN PESO CRISIS

The Golden Years 1988 –

Early 90s

After NAFTA Enactment

• Mexican Reform Program

• Healthy economy

• High foreign investment

• Low inflation rate

• Mexican miracle

• Overvalued exchange rate of peso to stabilise domestic inflation

• Lack of monetary policy → allowed short term investment without regulation

• Large scale of current account deficit → almost 8% of GDP

• Political uncertainties and the social risks

Mexican Peso Crisis

The Current Account Deficit

Peso per US Dollar

Source: Google

Death Foretold

Sudden Death

• Internal political shock: Assassination of presidential candidate Luis Donaldo Colosio

• External economic shock: the rise of interest rates in the United States• Overvalued exchange rate

& Unsustainable current account deficit

• Self-fulfilling expectations• Speculative attack

• Before the crisis: Fiscal policy → Conservative Debt ratio → Low by world Standard• Self-fulfilling expectations

became decisive in generating a panic only after the government ran down gross reserves and ran up short-term dollar debt.

Mexican Peso Crisis:Was it predictable?

Is the behaviour of the peso/dollar rate since 1995 broadly consistent with the behaviour of a typical floating exchange rate?

-The degree of volatility of the Mexican peso in 1995 was an order of magnitude higher than that of the typical floating exchange rate.

-The relative stability of the Mexican peso in 1996-97 was not excessive or grossly at odds with behaviour of other floating rates.

THE MEXICAN PESO IN THE AFTERMATH OF THE 1994 CURRENCY CRISIS

Did the Bank of Mexico follow some sort of feedback rule from the exchange rate to monetary policy during 1996-97?

-The BOM has systematically took into account the behaviour of the nominal exchange rate for conducing its short-run monetary policy during 1996-97.

THE MEXICAN PESO IN THE AFTERMATH OF THE 1994 CURRENCY CRISIS

•Wake up call for the emerging economies•Role of government in protecting the domestic economy.

a. Emphasis on savings

b. Improve banking system

c. Greater fiscal discipline

d. Consumer and investor protection•Effects of heavy reliance on international assistance.

WHAT HAS THIS CRISIS TAUGHT US?

•Appropriate Debt structure •Effects of high dependence on raising finance from external sources•Practice and promote fiscal discipline•Significance of timely data collection and its implications•Always consider any warning signs!

PRACTICAL IMPLICATIONS OF THE CRISIS

Do you think Mexico could have saved itself given the

early warnings? Why?

QUESTION

•The National Bureau of Economic Research www.nber.org •“Lessons of the Mexican Peso Crisis” - Council on foreign relations www.crf.org•Bloomberg Annual report www.bloomberg.com

REFERENCES