Case Study: Mexican Peso Crisis, 1994
From 1954 to 1976, Mexico had maintained a fixed exchange rate of Ps12.50/$. Even after the collapse of the Bretton Woods fixed exchange rate system in 1971/73, Mexico was able to hold this fixed rate.
Although the Mexican economy experienced rapid growth during most of the 1970s, it was progressively undermined by fiscal mismanagement in the form of large government borrowings (both home and abroad) which resulted in high rates of inflation and growing external indebtedness. As the international financial community’s concerns about Mexico grew, capital flight out of the country intensified.
In response to this international crisis, the ...view middle of the document...
The Mexican economy improved in the late 1980s and early 1990s. A series of price and wage control agreements signed by the government, labor unions, and private sector businesses in 1987 helped cut the inflation rate from 51 percent in 1988 to a low of 7 percent in 1994. Increased foreign trade and investment and a large-scale privatization of the country's state-owned companies helped the economy expand at a rate of more than 2.5 percent annually in the early 1990s.
By the early 1990s, Mexico was being hailed as a champion of free-market reform. President Carlos Salinas, a Harvard-trained economist, was seen as turning Mexico away from the traditional inward-looking policies of other Latin American countries towards an outward-oriented, market-driven economy. In an effort to enhance Mexico's competitive profile, Salinas also undertook a campaign to privatize state industries and deregulate the private sector. Salinas reduced foreign capital restrictions and took other steps to attract foreign investors, including cuts in public spending; as a result, the fiscal deficit was cut from 16 percent of GDP in 1987 to almost zero by 1994.
As for the exchange rate regime, the peso was still being determined by a managed floating arrangement. In 1993, the government introduced a new Mexican Peso, whereby one new Peso would be equivalent to 1000 of the former Mexican Pesos.
Between 1991 and 1993, more than $75 billion in foreign capital was funneled into Mexico, making it the world's second-largest recipient of foreign investment after China. The foreign...