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Tequila Crisis Essay

872 words - 4 pages

Mexico: The Tequila Crisis 1994-1995

What Caused Mexico’s peso crisis of December 1994?

Mexico, the Latin American country that survived the huge debt crisis in the 1980’s found itself amidst one of the most viral economic crises that it had ever encountered in its history. The crisis took place under President Zedillo; however, the causes of the crisis are usually linked to Carlos Salinas de Gortari and his outgoing administration. Gortari’s government currency policy put an unbelievable strain on the nation’s finances.
In the early 1990’s, Mexico seemed to have established itself as a reformer and was establishing economic development. Domestic deregulation and privatization ...view middle of the document...

This action caused an even more decline in the dollar reserves. The decisions that were being made aggravated the already delicate situation and crisis was inevitable so the only thing the government could do was to devalue the currency in order to make some sorts of adjustments. The devaluation caused even more of a crisis as it crashed the peso from four pesos to the dollar to 7.2 to the dollar in the space of a week (Boroumand, 2010)

Have Capital inflows helped or hindered Mexico’s development strategy?

Macroeconomic stabilization was implemented through the introduction of the “Pacto”. The Pacto was an agreement that was between the representatives and the government in support of the overall macroeconomic strategy (Boroumand, 2010). With the Launch of the Pacto, the nominal exchange rate was used as an anchor as it would contribute to the elimination of inertial inflation and at the same time guarantee that the fiscal policy would maintain the necessary discipline. The Pacto was successful in bringing inflation down but as experience shows the use of nominal exchange rate-based stabilization results in recurring real appreciation of the local currency because it always takes time for the differential between the domestic and foreign inflation to decrease and Mexico was not an exception.
The exchange rates real appreciation was exacerbated by the large amount of capital inflows experienced by Mexico in the early 1990’s. The capital inflows were the combined result of a deliberate policy of attracting private capital and the fall of the interest rates in the United States. The privatization of the banks that was announced in May 1990 and the intention to negotiate the free...

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