Summary
Economy bailout and recapitalization of the national banking system were the two major policies deployed by the Mexican government as a response to the peso crisis. Previously, it has been argued that a monetary school of economic thought dictated both policies. The flight of foreign investors disturbed by political instability created a critical lack of capital, forcing the government to implement measures to increase the inflow of money into the economy. A method of exclusion will help explain why the initial response to the crisis was predominantly monetary.
Firstly, one cannot explain the policies implemented by the Mexican government from the classical economics perspective. In particular, the government-arranged bailout and recapitalization of the banking system do not align with the fundamental principle of the market mechanism in classical interpretation. In a classical view, the market exhibits collective rationality that is not related to the intentions of the individual participants (Inoua & Smith, 2020). Therefore, third parties’ interventions in the market mechanism are undesirable. In the peso crisis case, the Mexican government had to deploy interventions, which made its actions contradictory to the classical school of economic thought.
Secondly, the anti-crisis policies introduced to resolve the peso crisis directly oppose the ideas of Keynesian economics. John Maynard Keynes, the founder of the school, argued that a government should intervene to stabilize the economy in case of emergency. However, Keynes’ perception of the necessary governmental interventions drastically differed from the policies implemented in Mexico. In particular, Keynes believed that the government should increase spending in times of economic recession in order to increase employment, stimulate consumer demand, and facilitate economic growth (Probasco, 2022). On the contrary, the Mexican government prioritized saving the banking system and battling inflation to prevent a default on sovereign debt.
Thirdly, one cannot claim that the Mexican government utilized supply-side measures to resolve the crisis. The key idea of supply-side schools is stimulating economic growth through increased production. This goal is achieved via policies favorable for private business owners, such as tax cuts and deregulation of certain industries (Amadeo, 2022). Improvements in business climate open opportunities for the creation of additional jobs. Consequently, the companies become able to increase the supply of products, thus driving economic growth. However, neither the bailout nor banking sector recapitalization in Mexico was based on supply stimulation. The government prioritized helping financial institutions instead of assisting the real sector.
Therefore, the exclusion method leaves only one possible answer — bailout and banking sector recapitalization were driven by the monetarist school. According to Amadeo (2021), monetarists believe that central banks have a greater influence on the economy because they control the supply of money. In the monetarist paradigm, the economy grows when the central bank increases the money supply available to enterprises and individuals. In the Mexican case, the Bank of Mexico experienced a lack of money due to investor panic and could not create extra currency since the peso had already depreciated. As a result, the money had to be borrowed from external sources — the IMF, the United States, and the BIS (McNamara et al., 2020; León Hoyos, 2021). Regardless of the source of funding, solutions to the peso crisis were based on increased money supply to the Mexican economy and active involvement of the Bank of Mexico in anti-crisis policies. Therefore, bailout and banking sector recapitalization should be regarded as policies driven by the monetarist school of economics.
Opinion on Policies Deployed by the Mexican Government
The policies introduced by the Mexican government succeeded in the resolution of the peso crisis. However, economic stabilization does not automatically mean that policies developed in the critical situation were flawless. For instance, the successful bailout negotiations with the INF and the United States initially failed to prevent the further weakening of the peso. The Mexican currency continued to depreciate throughout February 1995. The negative trend was reversed only in March 1995, when the government supplemented the bailout with fiscal policies, such as value-added tax rate increase and expenditure reductions (McNamara et al., 2020). Given these facts, the Mexican government should have implemented fiscal policies sooner instead of wasting several months of precious time in 1994 and the first months of 1995.
The Temporary Recapitalization Program (PROCAPTE) was also implemented with certain flaws that limited its practical effectiveness. According to León Hoyos (2021), PROCAPTE was met with mixed reactions in the banking sector since major financial institutions involved in the recapitalization effort failed to explain the program’s conditions to the banks. As a result, commercial bankers felt worried about joining PROCAPTE out of fear of losing control of their banks. In addition, PROCAPTE was criticized for keeping bad loans in recapitalized banks and not providing cash to the banks (León Hoyos, 2021). Consequently, some bankers sensed the lack of trust and respect from the government and avoided participating in the program. In this regard, the Mexican authorities could have increased the effectiveness of the banking sector recapitalization by allaying the fear of a government takeover among the bank owners and providing the banks with real cash.
References
Amadeo, K. (2021). Monetarism Explained. The Balance. Web.
Amadeo, K. (2022). Supply-side economics with examples: Does it work? The Balance. Web.
Inoua, S. M., & Smith, V. L. (2020). Classical economics: Lost and found. The Independent Review, 25, 79-90.
León Hoyos, M. (2021). Mexico peso crisis (1994–1995): PROCAPTE. The Journal of Financial Crises, 3(3), 474-497.
McNamara, C. M., Rhee, J., & Metrick, A. (2020). Restructuring and forgiveness in financial crises A: The Mexican peso crisis of 1994-95. The Journal of Financial Crises, 2(1), 82-95.
Probasco, J. (2022). Keynesian economics: A depression-era idea that’s seen a resurgence in the 21st century. Insider. Web.