Academic journal article The Cato Journal

The Recent Stabilization Experience in Mexico

Academic journal article The Cato Journal

The Recent Stabilization Experience in Mexico

Article excerpt

Since the late 1990s, Mexico has undertaken a stabilization program that reduced inflation to rates not seen in more than 30 years. The benefits of this progress have been substantial, including the improvement of living standards and the creation of an environment suitable for economic growth. Nevertheless, monetary policy still faces considerable challenges, among which the most important is reaching price stability, defined by the Bank of Mexico as a permanent annual inflation target of 3 percent.

The purpose of this article is to evaluate the achievements of Mexico's current stabilization program and identify its shortcomings in order to recommend measures for improvement. Emphasis is on the crucial role of monetary institutions in the progress attained, in particular, the inflation targeting approach under floating exchange rates and other complementary economic policies. Notwithstanding these achievements, the stagnation of disinflation since 2002 and the subsequent inability of the central bank to meet its inflation targets are identified as a major setback, which has damaged the credibility of monetary policy.

Behind the recent lack of development, serious limitations of the monetary strategy emerge, including a protracted tolerance of deviations from targets, particularly a propensity to be more reactive than preemptive in the fight against inflation. I warn of the risk of complacency and propose several basic steps to improve communication and operation of monetary policy to control inflation. Finally, Mexico's failures and successes provide some lessons for China, particularly the need to strengthen its banking system as a prerequisite of any monetary modernization.

Stabilization and Its Benefits

Since the mid-1990s, Mexico has experienced a substantial drop in inflation. As shown in Figure 1, this trend has been clearer since 1999, because beginning in that year average price growth has systematically fallen to levels not seen for a long time. At the end of 2003, annual price growth was 4 percent, the lowest rate in the last 31 years, which amounts to a decline of almost 15 percentage points compared with the end of 1998. This reduction contrasts with the country's economic past, characterized by high and volatile inflation. For example, in 1995 annual price growth was 52 percent and, despite various stabilization programs, from 1973 to 1999 it reached an average rate of 38.4 percent.

[FIGURE 1 OMITTED]

These results have yielded important benefits for the population and the economy, some of which are summarized in Table 1. Although at a decreasing pace due to the recent economic slowdown, lower inflation has allowed the recovery of real wages, which had been depressed in the past because of higher than expected price instability. For example, average annual growth of real contractual wages was 3.8 percent during 1999-2003, versus -8.9 percent in the previous four years; in those same periods, average annual inflation was 8.7 percent and 26.7 percent, respectively.

Nominal and real interest rates dropped, and during 2003, the former reached consecutive historic lows in all terms. The lower yields and the expectation that inflation will continue to be moderate have spurred financing, especially long-term. Thus, for the first time in Mexico's economic history, debt instruments in the securities markets have been developed in long-term contracts denominated in pesos at fixed interest rates. In 2001 and 2003, the federal government began to place 10- and 20-year bonds, respectively, with fixed interest rates in pesos. In addition, in 2001 a significant expansion began of stock certificates with maturities of up to 10 years, which are widely used by companies and various government levels.

Furthermore, since June 2002, the performing loan portfolio of the commercial banks to the private sector has grown continuously, compared with the previous year, and in 2004 this lending expansion included each main component: business, consumer, and mortgage loans. …

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