The Mid 1990s Peso Crisis in Mexico: An Application of the Girton-Roper Model

The Peso crisis is examined by using the exchange market pressure model (EMP) over the period 1971:1 - 1995:4. Different estimators are used to obtain robust results. Empirical findings indicate that an incrase in domestic credit, crisis dummy and inflation rates leads to outflows of foreign reserves and/or depreciation of the peso, while an incrase in foreign inflation and domestic income results in inflow of foreign reserves and appreciation of the peso. Sensitivity tests of the EMP to its composition between changes in exchange rate and foreign reserves, confirms that the Mexican economy absorbs the EMP through the loss of foreign reserves instead of the depreciation of the peso. This suggests that a fixed exchange rate regime is optimal for Mexico, and that timely external loans assistance from international institutions could have avoided the crisis. The later explains why Mexico recovered swiftly from the peso crisis after receiving external assistance.