Exchange Rate Crises in Developing Countries: The Political Role of the Banking Sector by Michael G. Hall

Author:Michael G. Hall [Hall, Michael G.]
Language: eng
Format: epub
Tags: International Relations, Political Science, General
ISBN: 9781351158435
Google: ik4PEAAAQBAJ
Goodreads: 38242345
Publisher: Routledge
Published: 2006-01-30T00:00:00+00:00

Official Explanations

In defending their decision to defend the crawling band instead of devaluing or floating, Mexican officials argued that a devaluation was unnecessary to correct current account deficits and that a devaluation might ignite inflation after a hard-won battle to reduce it. In regards to the current account deficit, the issue was whether the currency was overvalued, thus increasing imports and hurting export competitiveness for as long as it was overvalued, or whether the current account was temporary, the result of foreign investment, and would correct itself over time. If the currency was overvalued a devaluation or floatation would be necessary. If the current account deficits were temporary, a devaluation or floatation would be unnecessary and merely reduce the government’s credibility in making exchange rate commitments. In the early 1990s, government officials argued that the exchange rate was not overvalued and that the current account would correct itself.6 They argued that lower inflation and the neo-liberal reforms had attracted foreign investment inflows, which encouraged the current account deficits. Over time, foreign investment capital would improve Mexican productivity and Mexican exports. Thus the current account gap would close as the Mexican economy took off. NAFTA would allow even more foreign investment and export opportunities in the future. In the view of some government officials, the devaluation and floatation were unnecessary, and the peso crisis the result of a politically triggered panic among investors (Gil-Diaz and Carstens, 1997).

Critics that pushed the overvaluation interpretation, however, noted that several measures of inflation indicated that the real exchange rate was continuing to appreciate and that the use of the exchange rate to stabilize inflation frequently produces overvaluation in other countries (Dornbusch and Werner, 1994; Edwards, 1997). Furthermore, the critics argued that Mexican productivity figures were suspect (Dornbusch, 1997) and that economic growth in early 1994 not growing as quickly as the trade deficit (Wessel, et. al., Wall Street Journal, 6 July 1995, p.A4). In the view of the government’s critics, the peso crisis was the inevitable outcome of an unsustainable crawling band.

Whether or not the peso was overvalued and whether the peso crisis was due to mismanaged economic policy or a self-fulfilling panic are difficult questions that have been subject to extensive debate and that debate cannot be settled here. Comments by government officials and official government reports, however, show government officials insisting that the crawling band was not responsible for the current account deficits or the peso crisis. Perhaps by insisting that the exchange rate policy was not at fault, these officials were simply trying to deflect blame for their mistakes. It is plausible, however, that the rigid beliefs of officials, however mistaken, were sincere and help explain why the government persisted in defending the exchange rate. Pedro Aspe, then the foreign minister and the architect of the economic reform program, was reputed to have a dismissive attitude to those that questioned his economic policies (Wessel, et. al., Wall Street Journal, 6 July 1995, p.A4). This ideational approach alone, however, would not explain why

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