About the Existence of Common Internal Causes of Recent Latin American Currency Crises

Abstract

While the currency crises in Asia seem to have been one-of events, Latin America experiences recurring currency crisis. In this paper, we analyse whether common internal factors existed, that contributed to the build-up of the currency crisis. For our sample, we chose the three most recent Latin American currency crisis in Mexico 1994/95, Brazil 1998/99 and Argentina 2001/02. Each one of these three countries adopted a stabilization program with an exchange rate anchor as the central element among other liberal reforms in order to combat inflation. In a quantitative analysis for these stabilization periods, we work us step-by-step along the causalities chains that were started by the reforms. Our main findings include that to a considerable extent, the stabilization programs caused similar reactions in the three economies. Among these were a substantially overvalued currency, which implied considerable current account deficits and an elevation of the debt stock. In Brazil, increasing debt was less driven by the overvalued currency and more by fiscal indiscipline, while Mexican agents in 1994 faced a debt roll-over problem. Argentina suffered from its rigidities in the real sector, particularly the labor market, that did not allow adjustment, when imbalances increasingly built up over time. We conclude that the risk for crisis can be considerably dampened by prudent domestic policy making. However, the solidity of internal determinants alone will not be able to rule out turbulence.

Keywords: Currency Crisis, Latin America, Brazil, Mexico, Argentina, inflation stabilization, exchange rate peg

JEL Classification: F0