Mexican Peso Devaluation

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1. The trade and current account balances are negative which means they are in a deficit. This means that they are importing more than they are exporting. This also means that there is an excess supply of pesos in the world market. Since they are on a fixed exchange rate, the government is going to have to intervene and buy back pesos using its official reserves account. If Mexico’s foreign exchange balance is unable to effectively buy back pesos, they will be forced to devalue. 2. Since the private capital account is gradually increasing, it means the peso needs to be devalued. Generally the current account and the capital account balance are inversely related, meaning if the current account is negative then the capital …show more content…

7. The PPP is 22.38 pesos/USD based on formulas given from class. Given the new exchange rate of MP20.5/U.S$ I would say it is reasonably valued. It’s only slightly undervalued by less than $2 so the new exchange rate can definitely be considered reasonable. 8. If the Mexican government decided not to devalue the peso, there are some options they could’ve taken to keep their fixed rate. First, they could’ve raised the interest rates. This would make domestic assets more attractive to other countries, which would ultimately strengthen their currency. Raised interest rates, however, could potentially affect income levels and employment negatively. This is because when interest rates are higher, people generally tend to keep their money in the bank. Also, companies may be wary of taking out loans because of the high interest rate costs. Consumers keeping their money in the bank will cut spending, which will ultimately lead to less jobs and income. Also, if companies are afraid of taking out loans, they most likely will not expand which could create more income and job opportunities. Another approach is to buy pesos with its reserves of foreign currencies. They would do this because there is an excess supply of pesos in the world markets. This approach could in turn end up increasing its current account which would increase GDP. As GDP increases, so does employment

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