A nominal exchange rate anchor was a central element of the Mexican macroeconomic stabilization program. From March to May of 1988 the exchange rate was pegged to the dollar as part of a package of anti-inflationary measures. While by 1989 exchange rate policy had moved to a crawling peg, the nominal exchange rate remained a stabilized price in the economy. From the beginning of 1991 to the end of 1993 the nominal exchange rate depreciated by a total of only 5.4%.
While the exchange rate could be stabilized quickly, the over-all price level throughout the economy had much greater inertia, despite the presence of significant wage and price controls. From the beginning of 1991 to the end of 1993 Mexican wholesale prices rose about 30% relative to U.S. wholesale prices. The combination of a stabilized nominal exchange rate and inertia in inflation produced a real appreciation of the peso. By 1994 an indicator of the real exchange rate, namely the Mexican-US dollar rate relative to US and Mexican wholesale prices, showed a 20% over-valuation relative to its average value from 1970 to 1994.
In an important article in early 1994, Rudiger Dornbusch and Alejandro Werner agrued that the Mexican exchange rate was over-valued and that the over-valuation represented a major risk to the Mexican economy. Some other economists sounded similar warnings, but generally Mexican economic policy was lavishly praised as a model for the world. In retrospect, it is clear that the peso was over-valued, and that this problem should have been addressed in a more cautious and prudent manner.
Mexican Economic Crisis