Applications of Sudden Stops of International Capital to the Mexican Economy

Abstract

There was nothing in the fundamentals of the Mexican economy that would suggest at this point the beginning of a crisis of such magnitude. The 1994 crisis was extremely unexpected for both domestic and foreign firms and households, because there were good economic indicators so far together with the financial stability of the previous years. The Mexico of 1994 had a de jure fixed exchange rate regime, but in practice, it was an intermediate peg, not a serious hard peg. Our goal is to try to find out whether things would have been different if there would have been a floating exchange rate regime in place in Mexico at the time of the crisis of 1994 (instead of the fixed exchange rate regime that was actually in place).We set up a Dynamic Stochastic General Equilibrium Model (DSGE) that shared the main stylized characteristics of the Mexican economy of that time. We followed most of the features of Diamond and Dybvig (1983), since they model banks that can arise endogenously as transformers of maturities and liquidity providers; but we departed from their model significantly, since we introduced nontrivial features: the domestic country is a small open economy, there are two non fiat currencies who compete with each other, nontrivial exchange rate regimes. We modified accordingly the design of the deposit contracts offered by domestic banks to households, to obtain more flexible contracts that would allow us to analyze the potentially negative effects that a sudden stop would have had on this economy.

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Author Information
Paula Lourdes Hernández-Verme, Universidad de Guanajuato, Mexico
Mónica Karina Rosales Pérez, Universidad de Guanajuato, Mexico

• Category: Economics and Management

Posted by James Alexander Gordon

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