Joseph A. Whitt, Jr.
Economic Review, Vol. 81, No. 1, 1996
Hoping to avoid an economic slowdown during 1994, Mexico tried to maintain its quasi-pegged exchange rate while limiting monetary tightening by engaging in massive sterilized intervention—a policy that is not sustainable for long. The ultimate result was a collapse of the exchange rate, soaring interest rates, and probably a far worse recession than would have occurred if monetary policy had been tightened. The author of this article asks whether Mexican policy mistakes made devaluation of the peso inevitable, considering particularly Mexico's policy actions during 1994—as well as options Mexico did not take. He also reviews market response to the devaluation and Mexican and U.S. government efforts to cope with its aftermath. In his view this episode highlights the severe constraints on monetary policy that arise if a government wants to maintain a fixed or quasi-pegged exchange rate.
The ensuing crisis continues to have severe consequences for the Mexican economy. Nevertheless, the author sees hope that the combination of a relatively sound budget position, more effective Mexican policies since the devaluation occurred, and the assistance arranged by the United States and the International Monetary Fund will enable Mexico to recover much more quickly from this crisis than it did after its 1982 crash.