Question

Part 1 Question 1.

A. The US is Mexico’s most important trade partner. Explain at least two possible pathways of how increasing US short-term interest rates can hurt Mexico’s economy.

B. Similarly, explain two pathways through which the US decreasing short-term interest rates can help the Mexican economy.

C. Explain the pros and cons of having a fixed exchange rate, a policy that Mexico introduced as part of its reform package in the years prior to the crisis.

D. Explain some reasons for why financial sector privatization often leads to a credit boom, as was the case with Mexico in the 1990s.

Answer 1

1. Increased Us Interest rates will lead to higher investment inflow into US Economy for large investors causing lower investment inflow into Mexico. Moreover this will cause the Us dollar to appreciate against Mexican Peso and hence cause forex volatility.
2. On other hand, decreasing interest rates in US will lead to appreciation of Mexican peso and direct investment flow into Mexico. This will also make Mexicanbanks attractive for loan availability and hence higher liquidity and consumption will be possible causing GDP to rise in real terms in Mexico.
3. Fixed exchange rate promotes better currency stability, lowers volatility and devaluation. However disadvantages being can lead to current account imbalance and high conflicts with other macroeconomic variables.
4. Financial sector privatisation leads to added expansion and high capital expenditure which is naturally fundedby private banks and thus credit availability has to rise in shirt run to compensate for growth. This causes multiple tranches of liquidity and creates credit boom. Since government spending stops and deregulation occurs when privatisation takes place we see extensive spending and revenue expenditure and hence credit boom materialises.