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Capital Flows and Macroeconomic Management: Tequila Lessons
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1996
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Tequila EffectInternational Financial CrisisCurrency MovementsMonetary PolicyInternational FinanceRecent Financial DebacleEconomicsInternational Capital MarketLow VolatilityCentral Bank InterventionInternational Monetary SystemInternational Monetary EconomicsFinanceMacroeconomicsEconomic StabilityBusinessCurrency CrisesCurrency CrisisCapital FlowsFinancial Crisis
The paper examines Mexico’s 1994 financial debacle and its Tequila effect on emerging markets, arguing that financial factors can create self‑fulfilling equilibria that explain sudden reversals in Mexico and Argentina. The study compares Mexico’s financial crisis with Austria’s long‑term currency peg, focusing on financial factors in Latin America. The findings show that financial and liquidity factors, rather than current account or real exchange rate issues, drove Mexico and Argentina’s vulnerability to speculative attacks, while Austria’s stability stemmed from low monetary aggregate volatility, leading the authors to recommend that emerging markets prioritize banking system health, debt maturity, and exchange‑rate regime suitability.
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.