Capital Flows and Macroeconomic Management: Tequila Lessons

Abstract

This paper examines the recent financial debacle in Mexico and its effects on other emerging markets (the Tequila effect). I argue that financial and liquidity considerations—as opposed to current account sustainability or real exchange rate considerations—appear to have played a prominent role. Special attention is given to financial factors in Latin America. On this basis it is concluded that Mexico and Argentina were particularly vulnerable to speculative attacks. For contrast, the experience of Austria is examined and compared with that of Mexico. The analysis suggests that the remarkable stability of Austria—which pegged its currency to the Deutsche Mark for more than 15 years—may be due to the low volatility of its monetary aggregates. I also argue that financial factors could account for multiple self‐fulfilling equilibria, helping to explain the sudden and deep reversals in Mexico and Argentina. It concludes with a discussion on policy implications. I suggest that, aside from the usual fiscal prudence advice, countries should pay special attention to the banking system and the maturity of public debt. Furthermore, the appropriateness of an exchange rate regime should take into account the characteristics of the financial sector.

Currency crises in transition economies: An empirical analysis

“…The ratio of M2 to foreign exchange reserves can be interpreted as an indicator of reserves adequacy because, in the event of an exchange rate crisis or panic, liquid money Acta Oeconomica 53 (2003) assets can be converted into foreign exchange. This is in accordance with the work of Calvo (1996), which proposes that the ratio of M2 to foreign exchange reserves is a good predictor of a country's vulnerability to external crises (see Figures 1-4).…”

“…Even though high monetary growth does not nullify the influence of other variables (except for in the case of Russia), the significance of this variable tended to produce a range of "stylised" facts for our examined economies. 20 The higher the ratio of M2 to foreign exchange reserves, the highest the chance of a currency "episode" -which accords with previous findings stressing the importance of domestic money growth (see inter alia Frankel and Rose (1996), Calvo (1996)) lending support to the "fundamentals" perspective. Similarly, in Latin American cases the ratio of M2 to foreign exchange reserves appears to convey useful information on a country's financial vulnerabilities.…”

Currency crises in transition economies: An empirical analysis

“…The ratio of M2 to foreign exchange reserves can be interpreted as an indicator of reserves adequacy because, in the event of an exchange rate crisis or panic, liquid money Acta Oeconomica 53 (2003) assets can be converted into foreign exchange. This is in accordance with the work of Calvo (1996), which proposes that the ratio of M2 to foreign exchange reserves is a good predictor of a country's vulnerability to external crises (see Figures 1-4).…”

“…Even though high monetary growth does not nullify the influence of other variables (except for in the case of Russia), the significance of this variable tended to produce a range of "stylised" facts for our examined economies. 20 The higher the ratio of M2 to foreign exchange reserves, the highest the chance of a currency "episode" -which accords with previous findings stressing the importance of domestic money growth (see inter alia Frankel and Rose (1996), Calvo (1996)) lending support to the "fundamentals" perspective. Similarly, in Latin American cases the ratio of M2 to foreign exchange reserves appears to convey useful information on a country's financial vulnerabilities.…”

Giant Sucking Sound: Did NAFTA Devour the Mexican Peso?

“…Overviews of the events leading to the crisis may be found in OECD (1995), IMF (1995) or GAO (1996). Calvo (1996) and Garber and Lall (1996) discuss the roles played by capital flows and weakness in the Mexican financial system. Sachs, Tornell andVelasco (1995a and1995b) discuss the problems created by Mexico's dollar-linked debt instruments.…”

Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008

“…. Similar theoretical ideas have been discussed in the crisis literature, for example by Guillermo A Calvo (1996Calvo ( , 2006,Calvo and Enrique G. Mendoza (1996). Roberto Chang and Andrés Velasco (2001), Jeffrey D Sachs (1998),.…”

Currency crises in transition economies: An empirical analysis

“…The ratio of M2 to foreign exchange reserves can be interpreted as an indicator of reserves adequacy because, in the event of an exchange rate crisis or panic, liquid money Acta Oeconomica 53 (2003) assets can be converted into foreign exchange. This is in accordance with the work of Calvo (1996), which proposes that the ratio of M2 to foreign exchange reserves is a good predictor of a country's vulnerability to external crises (see Figures 1-4).…”

“…Even though high monetary growth does not nullify the influence of other variables (except for in the case of Russia), the significance of this variable tended to produce a range of "stylised" facts for our examined economies. 20 The higher the ratio of M2 to foreign exchange reserves, the highest the chance of a currency "episode" -which accords with previous findings stressing the importance of domestic money growth (see inter alia Frankel and Rose (1996), Calvo (1996)) lending support to the "fundamentals" perspective. Similarly, in Latin American cases the ratio of M2 to foreign exchange reserves appears to convey useful information on a country's financial vulnerabilities.…”

Giant Sucking Sound: Did NAFTA Devour the Mexican Peso?

“…Overviews of the events leading to the crisis may be found in OECD (1995), IMF (1995) or GAO (1996). Calvo (1996) and Garber and Lall (1996) discuss the roles played by capital flows and weakness in the Mexican financial system. Sachs, Tornell andVelasco (1995a and1995b) discuss the problems created by Mexico's dollar-linked debt instruments.…”

Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008

“…. Similar theoretical ideas have been discussed in the crisis literature, for example by Guillermo A Calvo (1996Calvo ( , 2006,Calvo and Enrique G. Mendoza (1996). Roberto Chang and Andrés Velasco (2001), Jeffrey D Sachs (1998),.…”

Currency crises in transition economies: An empirical analysis

“…The ratio of M2 to foreign exchange reserves can be interpreted as an indicator of reserves adequacy because, in the event of an exchange rate crisis or panic, liquid money Acta Oeconomica 53 (2003) assets can be converted into foreign exchange. This is in accordance with the work of Calvo (1996), which proposes that the ratio of M2 to foreign exchange reserves is a good predictor of a country's vulnerability to external crises (see Figures 1-4).…”

“…Even though high monetary growth does not nullify the influence of other variables (except for in the case of Russia), the significance of this variable tended to produce a range of "stylised" facts for our examined economies. 20 The higher the ratio of M2 to foreign exchange reserves, the highest the chance of a currency "episode" -which accords with previous findings stressing the importance of domestic money growth (see inter alia Frankel and Rose (1996), Calvo (1996)) lending support to the "fundamentals" perspective. Similarly, in Latin American cases the ratio of M2 to foreign exchange reserves appears to convey useful information on a country's financial vulnerabilities.…”

Giant Sucking Sound: Did NAFTA Devour the Mexican Peso?

“…Overviews of the events leading to the crisis may be found in OECD (1995), IMF (1995) or GAO (1996). Calvo (1996) and Garber and Lall (1996) discuss the roles played by capital flows and weakness in the Mexican financial system. Sachs, Tornell andVelasco (1995a and1995b) discuss the problems created by Mexico's dollar-linked debt instruments.…”

Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008

“…. Similar theoretical ideas have been discussed in the crisis literature, for example by Guillermo A Calvo (1996Calvo ( , 2006,Calvo and Enrique G. Mendoza (1996). Roberto Chang and Andrés Velasco (2001), Jeffrey D Sachs (1998),.…”