The High Cost of the Strong Peso and Its Temporary Nature: The Case of Mexico

Arturo Huerta G.

Economics Working Paper Archive from Levy Economics Institute

Abstract: The article analyzes why exchange rate stability has been prioritized in Mexico and why the national currency has appreciated; which policies and factors have made this possible, the costs and consequences of the strong peso, and its sustainability and temporality are also examined. Mexico's economy does not have the endogenous conditions necessary to maintain such a strong currency--which has relied on the inflow of capital, thus exposing the economy to high vulnerability vis-a-vis the behavior of capital flows. The exchange rate stability has been very costly, due to the fact that there is no longer an economic policy in favor of growth; furthermore, the entry of capital leads to continuous productive imbalances which are behind the external deficit. In essence, Mexico has fallen into the Ponzi effect, whereby debt covers the deficit and pays off debt. This article posits that an effective, flexible exchange rate should be used to lower the interest rate and increase public spending in favor of growth and employment, and that economic policy should aim to encourage import substitution and increase the domestic value added of exports in order to reduce the external deficit and capital inflow requirements. This should be accompanied by regulating the movement of goods and capital to avoid speculation and protect domestic production from imports, in turn allowing for a more flexible economic policy in favor of the productive sector and employment. Lastly, the article proposes that the economy should be financed with its own currency to boost growth potential and reduce the foreign trade deficit in order to avoid relying on external financing.

Keywords: Government and the Monetary System; Financial Markets and the Macroeconomy; Fiscal and Monetary Policy in Development; Policy Designs and Consistency; Financial Markets and the Macroeconomy; Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Foreign Exchange Policy; Factor Movement Policy (search for similar items in EconPapers)
JEL-codes: E42 E43 E44 E63 O23 O24 (search for similar items in EconPapers)
Date: 2025-01
New Economics Papers: this item is included in nep-inv, nep-mon and nep-opm
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