Question

2.

A. The US intervened to aid Mexico in 1995 with a $50 billion rescue loan from the US treasury, the IMF and private banks. The rationale for the rescue package was a “Tequila” effect of contagion to other emerging markets. Explain how this contagion from Mexico to other emerging markets could have occurred.

B. Even though the US rescue package to Mexico helped contain the crisis, many critics argued that it created a terrible precedent of moral hazard in which countries, knowing that they will be rescued, fail to maintain macroeconomic discipline and particularly, discipline with regards to foreign debt. With the benefit of hindsight, do you think critics were right?

Answer 1

Solution 2

The contagion effects occurs when one country declares bankruptcy or on verge of liquidity and cash crunch. This crunch causes trade deals and export imort payments to other emerging markets be frozen and thus cash crunch passes onto other markets and so on and so forth. Also the GDP resuces and plunges and creates ripple effects on unemployment as corporates post losses and thus recessioninary economic crisis spreads across other regions due to massive budget deficits and current account deficits and crashing stock prices.

Solution 3

Mexico encounters problem of moral hazard despite austerity measures are adopted as government spending reducesbut the foreign debt keeps increasing which is cost to IMF. Secondly, countries keep repeating such habits of excessive borrowing a, and promote tax cuts and discretionary spending in long run and pile up substantial debt despite the fact that any bankruptcy can have negative repurcussions on emerging markets and to avert such situations bailout will be made possible. The risk of IMF is borne to passon benefits to emerging markets causing problem of moral hazard.