The Collapse of the Mexican Peso: What Have We Learned?

Jeffrey Sachs, Aaron Tornell and Andres Velasco

No 5142, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

Date: 1995-06
Note: IFM
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Citations: View citations in EconPapers (63)

Published as Economic Policy, no. 22 (April 1996).

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Working Paper: The Collapse of the Mexican Peso: What Have We Learned? (1995)
Working Paper: The Collapse of the Mexican Peso: What Have We Learned? (1995)
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