Causes and Consequences of the Mexican Peso Crisis

Summary of Remarks of John Williamson to the Institute for International Economics, March 14, 1995

Dr. Williamson pointed out the similarities between Mexico in 1993 and Chile in 1981. At these points both countries had carried out extensive deregulation and privatization, reduced tariffs and stabilized inflation and the exchange rate. Both countries experienced substantial capital inflows and current account deficits -- 8% of GDP for Mexico in 1993 while 14% of GDP for Chile in 1981. When a balance of payments crisis struck Chile in 1982, output fell 14% and unemployment rose to 30%. But after a difficult period of adjustment, the Chilean economy emerged to become one of the strongest economies in Central and South America. The parallel between Mexico and Chile suggests that the cost to Mexico of a balance of payments crisis may be very signficant, while from a longer-term perspective the Mexican economy may still be developing along a propitious path.

Exchange rate over-valuation and the current account deficit were the two major problems in the Mexican economy in 1994. Given these problems, several additional factors helped to trigger the crisis: 1) elections, which are traditionally associated with devaluation, 2) the rise in U.S. interest rates, 3) loss of invester confidence due to politically linked assassinations, 4) loose monetary policy in response to the reduction in foreign capital flows, 5) expansion of quasi-fiscal expenditure via development bank credits, and 6) shifting fiscal borrowing to short-term, dollar-denominated instruments.

Dr. Williamson pointed out the importance of Mexico increasing its long-term domestic savings. A fall in savings contributed to the current account deficit. Williamson pointed to Chile's compulsory savings program (pension program) and the East Asian system of postal savings as some examples of policies that have been used to raise savings.

Topic Mexican Economic Crisis