TY - JOUR AU - Sachs,Jeffrey AU - Tornell,Aaron AU - Velasco,Andres TI - The Collapse of the Mexican Peso: What Have We Learned? JF - National Bureau of Economic Research Working Paper Series VL - No. 5142 PY - 1995 Y2 - June 1995 UR - http://www.nber.org/papers/w5142 L1 - http://www.nber.org/papers/w5142.pdf N1 - Author contact info: Jeffrey D. Sachs The Earth Institute at Columbia University 314 Low Library 535 West 116th Street, MC 4327 New York, NY 10027 Tel: 212/854-8704 Fax: 212/854-8702 E-Mail: sachs@columbia.edu Aaron Tornell Department of Economics UCLA 405 Hilgard Ave, Bunche Hall #8283 Los Angeles, CA 90095-1477 Tel: 310/794-1686 Fax: 310/825-9528 E-Mail: tornell@econ.ucla.edu Andres Velasco Columbia University School of International and Public Affairs 420 West 118th Street New York, NY 10027 Tel: 212/854-3899 E-Mail: avbranes@gmail.com AB - In the first quarter of 1995 Mexico found itself in the grip of an intense financial panic. Foreign investors fled Mexico despite very high interest rates on Mexican securities, an undervalued currency, and financial indicators that pointed to long-term solvency. The fundamental conditions of the Mexican economy cannot account for the entire crisis. The crisis was due to unexpected shocks that occurred in 1994, and the inadequate policy response to those shocks. In the aftermath of the March assassination the exchange rate experienced a nominal devaluation of around 10 percent and interest rates increased by around 7 percentage points. However, the capital outflow continued. The policy response to this was to maintain the exchange rate rule, and to prevent further increases in interest rates by expanding domestic credit and by converting short-term peso- denominated government liabilities (Cetes) falling due into dollar- denominated bonds (Tesobonos). A fall in international reserves and an increase in short-term dollar-denominated debt resulted. The government simply ended up illiquid, and therefore financially vulnerable. Illiquidity exposed Mexico to a self-fulfilling panic. ER -