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  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

References

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*

We would like to thank, without implication, Alex Cukierman, Robert Flood, Linda Goldberg, Mohsin Khan, Julio Santaella, Brian Stuart, Andrés Velasco, and Alejandro Werner for helpful discussions and comments on an earlier draft, Jeffrey Frankel for providing some of the data used here, and Brooks Calvo for research assistance. The paper has also benefited from comments of seminar participants at Strathclyde and Tilburg Universities.

1/

Models of speculative attacks in the Krugman-Flood-Garber tradition (see Agénor and Flood, 1994) have been used in numerous studies of exchange rate crises in developing countries. See, for instance, Cumby and van Wijnbergen’s (1989) study of Argentina, and Blanco and Garber (1986), Connolly and Fernandez (1987), and Goldberg (1994) on previous crises of the Mexican peso. See also Calvo (1995) for more recent models of foreign exchange crises, emphasizing notably the role role of foreign borrowing.

2/

It should be noted that this concept of credibility is by no means universal. Cukierman and Liviatan (1991), for instance, define credibility as the ability of the government to precommit its actions—that is, its capacity to convince private agents that it will carry out policies that may be time inconsistent.

3/

Our overview of the events leading to the peso crisis relies in part on International Monetary Fund (1995a, 1995b).

4/

See Aspe (1993) for a comprehensive overview of Mexico’s reform and stabilization during that period.

5/

Alternatively, the differential between Tesobono assets and U.S. interest rates could be calculated using the yield on U.S. Treasury bills. In practice, the choice between the two U.S. interest rate series is immaterial.

6/

As shown in Figure 6, however, prices of Mexican Brady bonds—fixed-income government paper issued in exchange for restructured commercial bank debt—indicate a modest increase in the perceived degree of country risk in the early part of 1994.

7/

As illustrated in Figure 6, prices of Mexican Brady bonds also fell sharply on international markets in the weeks following the peso collapse.

8/

Survey-based expectations do indicate that investors perceived a growing risk of devaluation between November 1993 and August 1994, that is, until the time of the presidential election (Figure 9). In September the perceived currency risk increased further, perhaps as a result of rumors of an impending change in-exchange rate policy. However, in October devaluation expectations were sharply revised downward.

9/

The lack of relevant and timely data on some important macro-economic aggregates (such as government spending and the level of foreign reserves) may have hampered investors’ assessments of Mexico’s situation during 1994, and may have led to the erroneous perception that economic policies were fundamentally sound. However, it should be noted that the issue of the sustainability of the external deficit did not emerge abruptly: the appreciation of the real exchange rate started in 1988, and the current account deficit had already reached very high levels in 1991.

10/

Zedillo was a member of the team that implemented the adjustment program under President Salinas.

11/

An alternative measure of devaluation expectations, as discussed earlier, is the survey measure produced by Currency Forecasters’ Digest, which represent “consensus forecasts” of some major companies. The Cetes-Tesobono interest rate differential, however, provides a more comprehensive measure of currency expectations held by all market participants.

12/

As recognized by many commentators, Mexico’s exchange rate regime was not very different from a fixed exchange rate: the exchange rate was at the ceiling of the band for most of 1994, and the ceiling itself was allowed to depreciate at a very gradual rate. For simplicity, therefore, we assume below that the nominal exchange rate is constant between devaluation episodes.

13/

Thus, in the Drazen-Masson framework, a restrictive monetary policy may in some circumstances harm, not help, the credibility of anti-inflation policy, if by depressing output it makes it more likely that an adverse output shock will further lower output to the extent that monetary policy will have to be eased later. However, this latter aspect is not developed here.

14/

As shown by Agénor (1994), the inflation-competitiveness tradeoff leads to a devaluation bias—in a similar manner to the-inflationary bias of the Barro-Gordon model. See also Andersen and Risager (1991).

15/

A more general multi-period formulation, along the lines of Drazen and Masson (1994), would allow considering the role of future potential gains in reputation in choosing today’s policies. However, such a specfication would complicate considerably the analysis, and would preclude the use of a closed-form solution for estimation.

16/

All data were taken from IMF International Financial Statistics, except for the Cetes-Tesobonos differential, which was calculated from data obtained from Merrill Lynch by Jeffrey Frankel, and data obtained directly from the Bank of Mexico. We used the Cetes-Tesobono differential for 91 day instruments, for March 1991 to May 1993, and the differential for 28-day instruments for June 1993 to November 1994, since no series was available for the complete period. Figure 4 shows that the two series evolve closely together during the May-June 1993 period of overlap.

17/

It should be noted that the inflation and interest rates are on a monthly basis, and expressed as decimal fractions (rather than as percentages). The coefficients in the state equation as well as the coefficient of πt in the difft equation (12) reflect this.

18/

Both considerations were important in Mexico in 1994. Several commentators have attributed the reluctance of the Mexican authorities to raise domestic interest rates after the Colosio assassination (in order to stem capital outflows) to their concerns with the banking system, which had shown signs of weakness since early 1993. The authorities were also concerned with potentially adverse effects on economic activity—a particularly important consideration prior to a presidential election in which, for the first time in-recent history, the election prospects for the ruling party’s candidate appeared uncertain.

19/

There is substantial anecdotal evidence suggesting that many private institutions involved in monitoring economic and financial developments in Mexico failed to “blow the whistle.” On November 22, 1994, for instance, in a report entitled Mexico: Zedillo reaffirms the Pacto, analysts at Salomon Brothers concluded that “although… an eventual more rapid depreciation of the peso may become necessary, the probability of a one-off devaluation is virtually nil.” On November 7, analysts at Bear, Stearns, in a report entitled Mexican Pesos and Cetes are Attractive, concluded that “political and technical problems have created an undervalued peso… We expect a strengthening of the peso in coming months, creating very high dollar returns on Cetes.” The very morning of the devaluation, clients of the firm received a report in which the same analysts continued to discount the risk of a currency adjustment.

20/

In the case of the United Kingdom, for instance, high unemployment Masson (1995), the large current account deficit associated with an overvalued exchange rate led to a loss of confidence in the sustainability of the exchange rate commitment within the exchange rate mechanism (ERM) of the European Monetary System. The devaluation that followed the U.K. departure from the ERM in September 1992, however, restored competitiveness and permitted lower interest rates, suggesting improved confidence in macroeconomic policy generally.

21/

These figures are calculated as follows. Using the cofefficient for πt in Table 1, and multiplying by 12 to convert to convert to an annual interest rate, we have 12·0.018· (1-0.3)·100 = 15.4 percent.

The Mexican Peso Crisis: Overview and Analysis of Credibility Factors
Author: Mr. Paul R Masson and Pierre-Richard Agénor