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Financial Crisis in Latin America & Mexico

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Financial Crisis in Latin America & Mexico. Jessica Hofer Megan Garcia. Start of Financial Crisis. 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 1981.

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start of financial crisis
Start of Financial Crisis
  • 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 1981.
    • This had a direct negative impact on the developing countries
other important factors
Other Important Factors
  • 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
what happened next
What 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
  • 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)
mexico s exchange rate
Mexico’s Exchange Rate
  • 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
cont 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
new government in mexico
New Government in Mexico
  • 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