Chapter 8: Mexico: Strong Currency and Weak Economy
Arturo Huerta THE IMPORTANCE OF NOMINAL EXCHANGE RATE STABILITY IN THE CONTEXT OF FINANCIAL LIBERALIZATION Financial liberalization, free capital mobility and the resulting internationalization of capital markets have increased the importance of managing the exchange rate. With currency devaluation in emerging market economies, ﬁnancial investments lose in dollar terms; but with nominal exchange rate stability and appreciation they gain through increased proﬁts in dollar terms. Exchange rate determination, therefore, becomes subordinated to the demands of international ﬁnancial capital. Governments and central banks in emerging market economies are forced to work towards low inﬂation and to equalize their inﬂation with that of developed countries. The emphasis on inﬂation is forced upon them in order to avoid shocks in nominal exchange rate parity and to safeguard proﬁtability conditions for international ﬁnancial capital, thereby ensuring a positive capital ﬂow to these countries. Exchange rate stability also becomes necessary in order to avoid speculative practices that are likely to cause instability in ﬁnancial markets. POLICIES TO ACHIEVE EXCHANGE RATE STABILITY The Latin American economies do not have the macroeconomic, productive and domestic ﬁnancial conditions to lower inﬂation and achieve nominal exchange rate stability via traditional means. Countries with low productivity and strong pressure on their macroeconomic fundamentals have been able to lower inﬂation through promoting capital inﬂow. They are then able to cover their current account deﬁcit and increase international reserves in order to face attacks from ﬂuctuations in international ﬁnancial markets and to ensure...
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