Why is 'The Market' so Unforgiving? Reflections on the Tequilazo

Abstract

Mexico’s financial debacle and its impact on other emerging markets (the Tequila effect) has raised many fundamental questions. Mexico achieved fiscal balance in 1993, undertook several fundamental market-oriented reforms, signed a free trade agreement with a very large market (the NAFTA), became a member of the OECD, and was hailed by international institutions as a paramount example of successful reform. Yet, the December 20, 1994, devaluation brought the economy down like a house of cards. Output fell by more than 7 percent in 1995, the current account deficit sharply swung from about 8 percent of GDP in 1994 to zero, and investors turned their noses away from high-yield Mexican public debt even though the international community had plunked about $50 billion in a rescue package. In addition, Mexican problems quickly spread around the world’s emerging markets, including those exhibiting long and enviable track records.