Case #1 – The Mexican Peso Crisis of December 1994
There are three different types of foreign exchange regimes that can be used by developing countries once their currency has stabilized. The first one is called the managed float. Also called the dirty float, the managed float is a system when exchange rates are able to change due to the nature of the market, but leaves the option for the government to intervene if the fluctuation is not desired. It is the regime that has been used by the monetary system since 1973. The second regime is called the crawling band. The crawling band, in this case, would combine Mexico’s crawling peg with a wider band. The crawling band is a compromise between a system of entirely fluctuating exchange rates and those that are inflexible. The parity levels would be adjusted either up or down as a moving average of the actual exchange rates that would fluctuate on a wider band. The exchange rate would be only allowed to move a maximum percentage. The amount of the percentage is called the annual crawling peg. The wider band that would cover the crawling peg would allow for the actual exchange rate to fluctuate. The third regime is called the floating exchange rate system. Also called the flexible exchange rate system, the exchange rate fluctuates based solely on market forces in this regime. A floating system allows countries to have independent monetary and fiscal policies. Also, central banks would not have to hold onto a large international reserve to back a fixed exchange rate system.
Capital flight was one of the main reasons for Mexico’s financial collapse of the peso. Capital flight is when assets and money flow out of a country due to an economic event that doesn’t assure investors things are okay. Capital flight differs from capital flow because capital flight occurs when investors feel that prices are about to fall and it becomes a race to get your money out before the prices fall. The assassination of...
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