Describe the Mexican peso crisis in terms of the imbalances that caused it, the policies Mexico used to respond, and the lessons learned

Question

What will be an ideal response?

Answer 1

Macroeconomic imbalances included an overvalued real exchange rate and a large current account deficit. Global capital markets became more conservative and risk averse. Given some instability in Mexico investors began to reassess whether Mexico was the safe, stable and modernizing economy they thought and began reducing their peso-denominated assets. To deal with the crisis, in the short run, loans and lines of credit were established with the IMF and the U.S. Austerity measures were imposed that included cuts in government spending, increased taxes and reduced consumption. For Mexico, relying too heavily on large foreign inflows to finance investment was unstable. Too much was in short term liquid portfolios rather than long term direct investment. Pegged exchange rate systems make it difficult to arrange an orderly devaluation as a single change may not be viewed as enough and cause the government to lose credibility. Flexible exchange rates or completely fixed exchange rates with no discretionary monetary policy options seem better.