ENC252

Course Description:


	This course will provide an in-depth study of events that resulted in the Mexican financial crisis of 1982, how the crisis was managed and solved, and how Mexico's current financial situation affects American banks and the economy of the United States.

Purpose of This Course:


	One of the objectives of the PVCC Mexico project is to increase access to information about Mexico, which makes sense, due to its size and vicinity.

To provide a better understanding of Mexico, it is truly necessary to promote a better understanding its economy. And to understand the economic situation of Mexico today, it is necessary to dwell with its huge public debt problem. Why and how did it develop? What can been done about it (if anything)? What has be done to solve it? How does it affect the outlook of Mexico into the future? How does all of this affect us? What can we do about it?

Competencies:

At the end of this course, the student should be able to:

1. Explain the domestic problems associated with public debt according to economic theory.

2. Describe international economic concepts (such as the balance of payments, foreign currency reserves and exchange rates) and explain their relationship to macroeconomic variables (such as aggregate output and interest rates).

3. Analyze the effects of public debt on the exchange rate, trade balance and foreign currency reserves, according to economic theory.

4. Explain and discuss the merits of the various forms of foreign exchange intervention, according to economic theory.

5. Describe the circumstances that led to the Mexican crisis of 1982 and its effects on the rest of Latin America. Discuss how such a crisis could have been avoided.

6. Describe the Baker and Brady financial restructuring plans for Mexico and other Latin American countries. Discuss the merits and limitations of these plans.

7. Discuss the possible effects of the NAFTA agreement on MexicoÕs financial and economic situation.

8. Describe the current financial and economic situation of Mexico. Explore and discuss possible future financial and economic scenarios in Mexico.

Texts:

Parkin: Macroeconomics, 3rd ed., Addison Wesley.

Paul R. Krugman & Maurice Obstfeld: International Economics, 4th ed.
Addison Wesley .

Alan Riding: Distant Neighbors, Vintage Books.

Note to the instructor: Students might be provided with a "Custom book," made out of photocopied material of the relevant chapters for this course, rather than have them purchase separately the three texts.

Suggested Support Material:


Mohamed A. El-Erian: Mexico's External Debt and the Return to Voluntary Capital Market
	Financing, IMF Working Paper WP/91/83.
Andrew Feltenstein: Tax Policy: and Trade Liberalization - An Application to Mexico, IMF Working
	Paper WP/92/108.
Claudio Loser & Eliot Kalter: Mexico: The Strategy: to Achieve Sustained Economic Growth, IMF
	Occasional Paper, No.99.
Tamin Bayoumi & Barry J Eichengreen: Monetary and Exchange Rate Arrangements for
	NAFTA, IMF Working Paper WP/93/20.
Guillenno E. Perry: Currency: Boards and External Shocks: How Much Pain, How Much Gain?
	World Bank Publication.
Shakil Faruqi: Financial Sector Reforms in Asian and Latin American Countries Lessons of
	Comparative Experience, Work Bank Publication.
Ian M. Little, Richard N. Cooper, W. Max Corden, & Sarath Rajapatirana: Boom Crisis and
	Adjustment: The Macroeconomic Experience of Developing Countries, 1970-90. World Bank Publication.
Country Analysis of Mexico, The Economist Intelligence Unit.
Overview of the North American Free Trade Agreement, Organization of American States-Trade
	Unit.
Note to the instructor: The instructor should use the IMF and World Bank publications mainly to
	draw material for class. The instructor might choose to include in the student's photocopies a few relevant pages of some of these papers, but it would not be realistic to have students read and understand the full length of the papers. The instructor might want to leave the papers on reserve in the library for interested students. The instructor should use the most current issue of The Economist Intelligence Unit country analysis of Mexico (or an equivalent source of current data) to discuss the material for week 16.


Outline:
Week 1:	Domestic economic policy and the long-run problems of public debt. (Parkin pp. 729-731,788,917,857-860)
Week 2:	National Income Accounting and the Balance of Payments. (Krugman & Obstfeld pp. 303-320)


Week 3:	Exchange rates and the Foreign Exchange Market. (Krugman & Obstfeld pp. 332-357)
Week 4:	Money, Interest Rates, and Exchange Rates. (Krugman & Obstfeld pp. 368-394)
Week 5:	Price Levels and the Exchange Rate in the Long Run. (Krugman & Obstfeld pp. 400-421)
Week 6:	Price Levels and the Exchange Rate in the Long Run. (Krugman & Obstfeld pp. 421-431) Output and the Exchange Rate in the Short Run. (Krugman & Obstfeld pp. 440-451)
Week 7:	Output and the Exchange Rate in the Short Run. (Krugman & Obstfeld pp. 451-472)
Week 8:	Fixed Exchange Rates and Foreign Exchange Intervention. (Krugman & Obstfeld pp. 488-504)
Week 9:	Fixed Exchange Rates and Foreign Exchange Intervention. (Krugman & Obstfeld pp.504-512) Latin American Countries: Debt, Stabilization, and Reform. (Krugman & Obstfeld pp. 684-693)
Week 10:	Applying Economic Theory of Debt, Stabilization, and Reform to Latin American Countries. (Krugman & Obstfeld pp. 693-715)
Week 11:	Mexican History of Public Debt Problems. (Riding pp. 194-219)
Week 12:	The 1982 Crisis and Its Aftermath. (Riding pp. 219-226; Little, Cooper, Corden & Rajapatirana)
Week 13:	The Baker and Brady financial restructuring plans for Mexico and other Latin American Countries. (El-Erian; Farugi; Little, Cooper, Corden & Rajapatirana).
Week 14:	The role of the exchange rate in Mexico. (Perry; Bayoumi & Eichengreen; Loser & Kalter; Little, Cooper, Corden & Rajapatirana)
Week 15:	NAFTA. (OAS: Chs. I, 3, II, 12 & 20)
Week 16:	Mexico's Current Economic and Financial Situation and Projections for the Future. (The Economist Intelligence Unit: Country Fact Sheet; Country Forecast Summary)

Class Requirements:

Prerequisite: Principles of Macroeconomics ECN I11.

The student will need to be proficient in basic algebra and should be able to interpret graphs.

All reading assignments (as stated in the course outline) must be completed prior to the date when they are due in class. The student should be prepared for unannounced quiz exams based on the readings.

The student is encouraged to attend all class sessions due to the complexity of the subject matter and the range of material to be covered. The mid-term and final exams may contain questions on topics covered in class discussion that might not have been present in the readings. Missing class might cause the student to miss quiz exams, which will not be offered extemporarily.

Final Project:

The student will be required to hand in a final written project at the end of the semester.

The project will involve extensive bibliographic research any aspect of the Mexican Debt problem that might interest the student and be approved by the instructor. The student should discuss the topic with the instructor during the first week of classes.

The student will have to present to the instructor an outline for his project within the first four weeks of classes.

The student will have to present a rough draft of the project to the instructor by the date of the mid-term exam, for the instructor to evaluate and suggest improvements on.

The student will have to present the final version of the project at least two weeks before the end of the semester.

Grading:

The final grade will be computed according to the following weights:

25% Quiz Exams.

25% Mid-term Exam. 25% Final Exam.

25% Final Project.


Week 1: Domestic Economic Policy and the Long-Run Problems of Public Debt. What can policy do? Policy goals:
	Potential GDP growth The business cycle Unemployment Inflation The two core policy indicators: Real GDP growth and inflation
Fiscal policy in the long-run
	A burden for future generations? Crowding out Ricardian equivalence
Monetary policy in the long-run
	The ripple effect of monetary policy
The exchange rate effects of debt


Week 2: National Income Accounting and the Balance of Payments Discuss the National Income accounts:
	National Product and National Income Capital depreciation, international transfers, and indirect business taxes Gross Domestic Product
Discuss the National Income accounting for an Open Economy:
	Consumption Investment Government purchases The National Income identity for an open economy The current account and foreign indebtedness Savings and the current account Private and government savings Effects of government budget deficit on current account
The Balance of Payments accounts
	Paired transactions and balance of payments identity The current account The capital account The statistical discrepancy


Week 3: Exchange Rates and the Foreign Exchange Market Exchange rates and international transactions
	Domestic and foreign prices Exchange rates and relative prices
The foreign exchange market
	The actors Characteristics of the market Spot rates and forward rates Foreign exchange swaps Futures and options
The demand for foreign currency assets
	Risk and liquidity Interest rates Exchange rates and asset returns Return, risk and liquidity in the foreign exchange market
Equilibrium in the foreign exchange market
	Interest parity: the basic equilibrium condition How changes in the current exchange rate affect expected returns The equilibrium exchange rate
Interest rates, expectations and equilibrium
	The effect of changing interest rates on the current exchange rate The effect of changing expectations on the current exchange rate


Week 4: Money, Interest Rates, and Exchange Rates Defining money
	Money as a medium of exchange Money as a unit of account Money as a store of value How the money supply is determined
The demand for money by individuals
	Expected return Risk Liquidity
Aggregate money demand The equilibrium interest rate
	Equilibrium in the money market Interest rates and the money supply Output and the interest rate
The money supply and the exchange rate in the short run
	Linking money, the interest rate, and the exchange rate U.S. Money supply and the Dollar/peso exchange rate Mexican money supply and the dollar/peso exchange rate
Money, the price level, and the exchange rate in the long run
	Money and money prices The long run effects of money supply changes Empirical evidence on money supplies and price levels Inflation and money supply growth in Latin America Money and the exchange rate in the long run
Inflation and exchange rate dynamics
	Short run price rigidity versus long run price flexibility Money supply growth and hyperinflation in Bolivia Permanent money supply changes and the exchange rate Exchange rate overshooting


Week 5: Price levels and the exchan2e rate in the Long run The law of one price Purchasing power parity
	The relationship between PPP and the law of one price Absolute PPP and relative PPP
A long run exchange rate model based on PPP
	The fundamental equation of the monetary approach Ongoing inflation, interest parity, and PPP The Fisher effect
Empirical evidence on PPP and the law of one price Explaining the problems with PPP
	Trade barriers and nontradables Departures from free competition International differences in price level measurement PPP in the short run and in the long run Why prices are lower in Mexico


Week 6: Price levels and the exchange rate in the Long run (Continued) Beyond purchasing power parity: A general model of long run exchange rates
	The real exchange rate Demand, supply, and the long run real exchange rate Nominal and real exchange rates in the long run equilibrium
International interest rate differences and the real exchange rate Real interest parity Output and the Exchange Rate in the Short R Determinants of aggregate demand in an open economy
	Determinants of consumption demand Determinants of the Current account How real exchange rate changes affect the current account How disposable income changes affect the current account
The equation of aggregate demand
	The real exchange rate and aggregate demand Real income and aggregate demand
How output is determined in the short run Output market equilibrium in the short run: the DD schedule
	Output, the exchange rate, and output market equilibrium Deriving the DD schedule Factors that shift the DD schedule
Asset market equilibrium in the short run: the AA schedule
	Output, the exchange rate, and asset market equilibrium


Week 7: Output and the Exchange Rate in the Short Run (Continued) Asset market equilibrium in the short run: the AA schedule
	Deriving the AA schedule Factors that shift the AA schedule
Short run equilibrium for an open economy: putting the DD and AA schedules together Temporary changes in monetary and fiscal policy
	Monetary policy Fiscal policy Policies to maintain full employment
Inflation bias and other problems of policy formulation Permanent shifts in monetary and fiscal policy
	A permanent increase in the money supply Adjustment to a permanent increase in the money supply A permanent fiscal expansion
Macroeconomic policies and the current account Gradual trade flow adjustments and current account dynamics
	The J-curve Exchange rate pass-through and inflation Mexico's trade balance and the peso's exchange rate


Week 8: Fixed Exchange Rates and Foreign Exchange The relevance of fixed exchange rates Central bank intervention and the money supply
	The central bank balance sheet and the money supply Foreign exchange intervention and the money supply Sterilization The balance of payments and the money supply
How the central bank fixes the exchange rate
	Foreign exchange market equilibrium under a fixed exchange rate Money Market equilibrium under a fixed exchange rate A diagrammatic analysis
Stabilization policies with a fixed exchange rate
	Monetary policy Fiscal policy Changes in the exchange rate Adjustment to fiscal policy and exchange rates


Week 9: Fixed Exchange Rates and Foreign Exchange Intervention (Continued) Balance of payments crisis and capital flight Managed floating and sterilized intervention
	Mexico's 1994 balance of payments crisis Perfect asset substitutability and the ineffectiveness of sterilization intervention Foreign exchange market equilibrium under imperfect asset substitutability The effects of sterilized intervention with imperfect asset substitutability Evidence on the effects of sterilized intervention The signaling effect of intervention
Latin American Countries: Debt Stabilization and Reform Income and wealth in the world economy Macroeconomic features of Latin American countries
	Undeveloped financial markets Government's pervasive role Inflation and the government budget Pegged exchange rates, exchange controls, and inconvertible currencies The structure of Latin American country exports
Latin American countries borrowing and debt
	The economics of borrowing by Latin American countries Alternative forms of capital inflow Government and publicly guaranteed borrowing


Week 10: Latin American Countries: Debt- Stabilization- and Reform Latin American borrowing in historical perspective
	Capital flows to Latin American countries before 1914 The interwar period and its aftermath: 1918-1972 The Paris Club Borrowing after 1973: oil shocks and floating interest rates
Latin American debt crisis of the 1980s
	Leading up to the crisis Latin American countries in the worldwide recession The beginning of the crisis Managing the debt crisis Renewed capital inflows
Trying to tame inflation in the developing world
	The Latin American Tablitas of the 1070s Heterodox versus orthodox stabilization Stabilization with heterodox elements Why the currency appreciates in real terms during inflation stabilization Lessons
The road ahead


Week 11: Mexican History of Public Debt Problems 19th Century Mexican finances
	External debt in the 19th century with Spain, France and Britain. Reasons for Mexico's external debt default at the mid 19th century. Political and economic consequences the default.
Early 20th Century Mexican finances
	Early 20th century economic and financial situation of Mexico. Economic effects of the nationalization of the oil industry and of the second world war.
Policies of the 1970s that led to the 1982 financial crisis.
	Luis Echeverria Alvarez's presidency. Jose Lopez Portillo's presidency.


Week 12: The 1982 Crisis and Its Aftermath International financial environment of the late 1970s.
	Low floating interest rates. Too much credit and too few qualified borrowers. Mexico's popularity as a borrower.
The "ancestral needs" of the Mexican population.
	Using oil reserves as collateral for loans. The "petrolification" of the economy. The many ways in which the money was squandered. Corruption. Where did the dollars go?
Exchange rate policy
	The fixed exchange rate policy. Differences in inflation between the U.S. and Mexico. The effects on trade.
The crisis.
	The international financial markets fail to spot the Mexican financial strains. International borrowing switches to short term debt. The "Burro Bonds". Lopez Portillo' s pledge to defend the peso like a dog. The devaluation.
The potential impact of Mexico's crisis on America's financial institutions The fall-out effect of the Mexican debt crisis on other Latin American countries.


Week 13: The Baker and Brady Financial Restructuring Plans for Mexico and Other Latin American Countries Setting up the Baker plan.
	American banks: their exposure problem and the free-rider problem Voluntary versus involuntary loans The roles of IMP and the World Bank.
Performance and problems of the Baker plans.
	Recognizing that the Mexican debt problem was more than a simple short-run liquidity problem. Rethinking the Baker plan: restructuring the debt from short-term to long-term. The 1986 crisis: the price of oil drops again.
Setting up the Brady Plan.
	The debate on thinking the unthinkable: pardoning part of Mexico's debt. The three options offered to Mexico's creditors: 1) Pardoning part of the debt and restructuring remaining debt into fixed interest bonds. 2) Lending new money to Mexico in exchange for not having to pardon any debt. 3) Swapping part of Mexico's debt for Mexican assets.
The performance of the Brady plan.
	The options creditors chose. The secondary Mexican debt market and the writing off of Mexican debt. The economic policies of Salinas. The performance of the Mexican economy. The application of the Baker and Brady restructuring plans to other Latin American countries.


Week 14: The Role of The Exchange Rate in Mexico Political importance of the exchange rate and devaluations in Mexico. A Historical perspective.
	Aleman sets the pace with import substitution, economic growth, stable prices and a fixed peso/dollar exchange rate.
Echeverria changes the rules.
	Echeverria' s unorthodox economic policies and their effect on prices, the external debt, and on the exchange rate. The mixed blessing of new-found reserves of oil under Echeverria.
Lopez Portillo follows on.
	The effect of Lopez Portillo's "petrolification of the economy," on prices, on the external debt, and on the exchange rate.
Political cycle of exchange rate devaluations.
	The political expediency of having devaluations right after presidential elections but before the new president begins his term. The gross over-spending on political campaigns and their effect on prices and the exchange rate. The problem of political and economic uncertainty during an election year: how worries and expectations lead to devaluations as money flows away to the U.S.
De La Madrid breaks expectations
	How De La Madrid managed to avoid devaluations in his presidency.
The Administration of Salinas
	Using the exchange rate as a macroeconomic tool to reduce inflation. Salinas's determination to avoid a devaluation. The economic forces that led to a devaluation right after Salinas leaves office. Why Mexico seemed to be doing so good and yet crashed again anyway.
The current situation with Mexico's exchange rate.
	The continuing strains of relative inflation on the exchange rate. A managed exchange rate: today's so-called "floating" exchange rate. 'Why not a truly floating exchange rate?


Week 15: NAFTA Mexican hopes pinned on NAFTA
	NAFTA and the theory of export led growth. Using NAFTA to reduce uncertainty on future macroeconomic policy. Using NAFTA to enhance the competitiveness of Mexican industry. Using NAFTA to make Mexico more attractive to foreign investment. The joining the rich might just make us richer" argument.
Mexican fears of NAFTA
	The inadequacy of Mexican industry to confront open international competition. The mistrust of foreign investment in Mexico. The issue of sovereignty.
The possible economic influences of NAFTA
	Mexico's long-term growth. Trade. The exchange rate. Mexico's public debt.
The performance of NAFTA so far.


Week 16: Mexico’s Current Economic and Financial Situation and Projections for the Future The macroeconomic policies of Zedillo
	On the exchange rate. On trade and NAFTA. On inflation and growth. On economic liberalization.
The growing concern on political stability.
	The various factions within the PRI. The opposition parties' progress. The attitude of the military.
Investment in the future.
	Should foreign investors trust Mexico? What Mexican investors are doing with their money. Finding ways to stimulate more private savings in Mexico: is Chile a good model to follow on pensions?
Government finances.
	The effects of lower inflation and interest rates on government spending. Increasing revenue without increasing taxes: the benefits of a simpler tax code; Laffer's curve, the black market and lower taxes.
The future of NAFTA. What the U.S. can do to help.

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