The Collapse of the Mexican Peso: What Have We Learned?, Issue 5142
National Bureau of Economic Research, 1995 - Currency question - 33 pages
In the first quarter of 1995 Mexico found itself in the grip of an intense financial panic. Foreign investors fled Mexico despite very high interest rates on Mexican securities, an undervalued currency, and financial indicators that pointed to long-term solvency. The fundamental conditions of the Mexican economy cannot account for the entire crisis. The crisis was due to unexpected shocks that occurred in 1994, and the inadequate policy response to those shocks. In the aftermath of the March assassination the exchange rate experienced a nominal devaluation of around 10 percent and interest rates increased by around 7 percentage points. However, the capital outflow continued. The policy response to this was to maintain the exchange rate rule, and to prevent further increases in interest rates by expanding domestic credit and by converting short-term peso- denominated government liabilities (Cetes) falling due into dollar- denominated bonds (Tesobonos). A fall in international reserves and an increase in short-term dollar-denominated debt resulted. The government simply ended up illiquid, and therefore financially vulnerable. Illiquidity exposed Mexico to a self-fulfilling panic
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adjustment Argentina Banco de Mexico band bank reserves banking sector banking system borrowing Center for International Cetes CM CM CM collapse commercial banks consumption countries course of 1994 credibility creditor panic crisis currency board current account deficit December decline denominated depositors depreciation domestic credit expansion domestic interest rates Economic exchange rate changes expand domestic credit fall Figure finance the current financial deepening financial panic financially vulnerable fiscal fixed exchange rate foreign assets foreign exchange reserves foreign investors government debt Harvard University higher interest rates illiquid inflation last resort lender of last levels loans Mexican Central Bank Mexican Government Mexican Peso Mexican securities Monetary Base nominal devaluation nominal exchange rate pegged exchange rate percent of GDP policy response policymakers private sector public debt ratio real exchange rate relative price reserve losses result risk premium short-term debt short-term liabilities Table Tesobonos tradeable University and NBER