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A Tale of Two Crises: Chile and Mexico

  • Sebastian Edwards

The Mexican peso crisis of December 1994 sent shock waves through the world's financial and policy communities. What is to some extent surprising is not that the Mexican economy faced a major currency crisis, but that so many analysts and observers were shocked by this turn of events. Mexico had a remarkable historical precedent: merely a dozen years earlier Chile suffered a prophetically similar crisis. Like Mexico during the 1980s, Chile during the 1970s undertook major structural reforms characterized by a drastic opening of the economy, a sweeping privatization program and a major deregu- lation effort aimed at creating a modern financial sector. In Chile, as in Mexico more than a decade later, the use of a predetermined exchange rate to eliminate inflation, combined with very large capital inflows that were intermediated by a weak banking system, generated a situation of exchange- rate overvaluation, a vulnerable financial sector and eventually the collapse of the currency. This paper provides a comparative analysis of some macroeconomic aspects of the Chilean and Mexican crises and discusses the extent to which exchange-rate-based stabilization programs are successful in reducing or even eliminating inflationary inertia? The paper provides a brief overview of the Chilean and Mexican reform and stabilization programs started in 1975 and 1985. I develop a theoretical model on the effects of exchange- rate-based stabilization programs on inflationary inertia. The model emphasizes the roles of government preferences and credibility. I use detailed data on Chile and Mexico to assess whether these programs affected the time series properties of inflation; more specifically, I investigate whether they reduced inflationary inertia.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5794.

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Date of creation: Oct 1996
Date of revision:
Publication status: Published as "Exchange-Rate Anchors, Credibility, and Inertia: A Tale of Two Crises, Chile and Mexico", American Economic Review, Vol. 82, no. 2(May 1996): 176-180.
Handle: RePEc:nbr:nberwo:5794
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  1. Rudiger Dornbusch & Stanley Fischer, 1991. "Moderate Inflation," NBER Working Papers 3896, National Bureau of Economic Research, Inc.
  2. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
  3. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
  4. Bruno, M., 1991. "High Inflation and the Nominal Anchors of an Open Economy," Princeton Studies in International Economics 183, International Economics Section, Departement of Economics Princeton University,.
  5. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  6. Stanley Fischer, 1984. "Contracts, Credibility, and Disinflation," NBER Working Papers 1339, National Bureau of Economic Research, Inc.
  7. Rudger Dornbusch & Ilan Goldfajn & Rodrigo O. Valdés, 1995. "Currency Crises and Collapses," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 219-294.
  8. Guillermo A. Calvo, 1995. "Varieties of Capital-Market Crises," Research Department Publications 4008, Inter-American Development Bank, Research Department.
  9. Rudiger Dornbusch & Alejandro Werner, 1994. "Mexico: Stabilization, Reform, and No Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(1), pages 253-316.
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