F INANCIAL C RISIS IN L ATIN A MERICA & M EXICO Jessica Hofer Megan Garcia

S TART OF F INANCIAL C RISIS In 1979, the US Federal Reserve adopted a tough anti-inflation policy which raised dollar interest rates and helped push the world economy into recession by This had a direct negative impact on the developing countries

O THER I MPORTANT F ACTORS Immediate rise in the interest burden that debtor countries had to pay Substantial rise in the real value of dollar debt burden Primary commodity prices collapsed, depressing terms of trade of many poor countries

W HAT HAPPENED NEXT ? Mexico announced in 1982 that its central bank had run out of foreign reserves and could no longer meet payments on foreign debt Large private lenders cut off new credits and demanded repayment on earlier loans from other Latin American countries Widespread inability of developing nations to meet prior debt obligations Sometimes referred to as the “lost decade” of Latin American growth

M EXICO Introduces a broad stabilization and reform program in 1987 Reduction in public-sector deficits and debts Using exchange rate targeting and wage-price guidelines Committed to free trade by joining various organizations (GATT, OECD, NAFTA)

M EXICO ’ S E XCHANGE R ATE Fixed peso’s exchange rate to the US dollar in 1987 Moved to a crawling peg in early 1989 and then later to a crawling band in 1991 Government annually announced a rising limit on the currency’s allowable extent of depreciation, permitting a range of fluctuation Peso appreciated sharply in real terms and created a large CA deficit Over 1994, foreign exchange reserves fell to very low levels

C ONT ’ D Government continued to extend credit to banks experiencing loan losses Mexico rapidly privatized banking without regulatory safeguards Banks had free access to foreign funds Banks were confident they would be bailed out if they met trouble

N EW G OVERNMENT IN M EXICO In 1994 a new government took over and devalued the peso 15% beyond the limit promised previously This was attacked by spectators and the government switched to a floating exchange rate Foreign investors panicked; Mexico was unable to borrow except at penalty interest rates Experienced similar financial crisis as in 1982, only to be bailed out by a $50 billion emergency loan from the US Treasury and IMF

M EXICO ’ S I NFLATION