Currency Crises, Monetary Union and the Conduct of Monetary Policy: A Debate among Leading Economists

By Paul J. Zak | Go to book overview

6. The Monetary Crisis in Mexico

Introduced by Bob Solomon

Corden This afternoon's session is going to be devoted to various issues connected with developing countries. It will be introduced by Bob Solomon. Before we start, I just want to raise one point for the record. We had the great Mexican crisis [in 1994], and then we had the rescue with mostly US money on the principle that Mexico was illiquid but solvent. Looking back now, was that a good move or not? My impression is that it was. Certainly the US hasn't lost out on it. The money has been paid back. That then raises a question in my mind. Everytime there is illiquidity, that implies the market is not entirely rational. If everybody accepted the fact that the borrower is fundamentally solvent, they shouldn't be illiquid should they? This raises some questions about market agency, and this is a case where the US government, if I may say so, Milton, has possibly shown better judgment than the private market.

Solomon: What we're looking at is the decade of the 1990s. We have the lost decade of the 1980s following the debt crisis that began in 1982, affecting a lot of developing countries. Something happened towards the end of the 1980s and the beginning of the 1990s that led to an increase in capital flows to a large number of foreign countries. Not only foreign direct investment, but quite a bit of portfolio capital went to developing countries. Of course, it goes without saying that portfolio capital is much more volatile than foreign direct investment. That leads to the possibility of crises. Then there was the case of Mexico. The issue is not merely whether it was a liquidity or solvency crisis, but whether it could have been avoided.

At the same time, there are quite a number of developing countries outside Latin America, particularly in East Asia and

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