“Mexico’s Balance-of-Payments Problem”

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Mini Case “Mexico’s Balance-of-Payments Problem” In December of 1994 Mexico entered its second major financial crisis in as many decades, requiring painful economic adjustment similar to the debt crisis of 1982. After nearly a decade of stagnant economic activity and high inflation in Mexico, the Mexican government liberalized the trade sector in 1985, adopted an economic stabilization plan at the end of 1987, and gradually introduced market-oriented institutions. Those reforms led to the resumption of economic growth, which averaged 3.1 percent per year between 1989 and 1994. In 1993 inflation was brought down to single-digit levels for the first time in more than two decades. As its economic reforms advanced, Mexico began to attract…show more content…
In short, the economy seemed to be poised for sustained economic growth with low inflation, that would lead to increases in per-capita income that had been unobtainable during the previous decade. • The beginning: In late 1987, Mexico was facing 140% annual inflation. To solve this problem, government engaged in an aggressive stabilization program with wage freeze and administered prices. Exchange rate was fixed and became the main anchor of the program starting from February 1988. Between 1988 and 1994, exchange rates went through several adjustments. In 1989 a pre announced devaluation regime where nominal devaluations were set below inflation rate was followed. Then in 1991, they went on to a narrow exchange rate band with a sliding ceiling. Between1992-93, NAFTA agreement was in the center stage boosting investor confidence. During which peso was fairly stable, remaining in the lower half of the band. In the first 18 months of the program, inflation fell to less than 20 percent but then the pace of disinflation became very slow. It should also be mentioned that between1992-94 capital inflow to Mexico was 7 percent of GDP. There were also discussions regarding the appreciation of peso together with the growing current account deficit which was being financed by these inflows. To avoid the problem of rolling over a sizable amount of domestic debt at high interest rates and further rise in interest rates, Mexico had a crucial

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