The Mexican Peso Crisis: Overview and Analysis of Credibility Factors
IMF Working Papers, January 1, 1996
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- The Mexican Peso Crisis: Overview and Analysis of Credibility Factors
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Bibliographic details
- Authors: Paul R Masson, Pierre-Richard Agénor
- Published: January 1, 1996
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451929096.001
Summary
- This paper examines credibility and reputational factors in explaining the December 1994 crisis of the Mexican peso.
- After reviewing events leading to the crisis, a model emphasizing the inflation-competitiveness trade-off is presented to explain the formation of devaluation expectations.
- Estimation results indicate that investors appear to have seriously underestimated the risk of devaluation, despite early warning signals.
- The collapse of confidence that followed the December 20 devaluation may have been the result of a shift in the perceived commitment of the authorities to exchange rate stability.
Model and Analytical Framework
- Emphasis on an inflation-competitiveness trade-off to explain formation of devaluation expectations.
- Key concepts and keywords used in the analysis: Competition, Crawling peg, devaluation expectation, devaluation probability, devaluation rate, exchange rate, exchange rate band, Exchange rates, Inflation, inflation-competitiveness tradeoff, interest rate differential, Mexican peso, perceived devaluation risk, peso devaluation, Real exchange rates.
Empirical Findings
- Estimation results conclude investors underestimated devaluation risk prior to December 1994.
- Early warning signals were present but did not prevent mispricing of devaluation probability by investors.
- The December 20 devaluation corresponded with a collapse of confidence tied to a perceived shift in authorities' commitment to exchange rate stability.