Questions about the Foreign Exchange aspects of a Latin American Country (Mexico)

Questions about the Foreign Exchange aspects of a Latin American Country (Mexico)

Questionsabout the Foreign Exchange aspects of a Latin American Country(Mexico)

Questionsabout the Foreign Exchange aspects of a Latin American Country(Mexico)

Question1

TheLatin country under discussion is Mexico. After the 1995 economiccrisis in Mexico, its government decided to adopt a variable foreignexchange rate regime since it is more sustainable and reliable. Aforeign exchange speculator and advisor to the treasury is a veryimportant portfolio in government because all the monetary and fiscalpolicies that the government decides to undertake are contingent uponthe advice. Furthermore, the quality of the advices provided to thetreasury should take both the professional and experiential aspectsof the foreign exchange markets as it is on the contemporary market. The role of the foreign exchange advisor to the government is toensure that the government makes the best decisions while maintaininga stable foreign exchange rate in the country. Furthermore, thegovernment controls all the decisions made by the Central Bankhence, the responsibility to minimize foreign exchange fluctuationslies in the treasury. Although the main actions that the government,through the treasury, takes when there are fluctuations in foreignexchange are either to buy or sell off the Mexican Peso, the decisionto do so follows a series of careful considerations on the state ofthe economy both locally and on the international stage. There arealso other facets of the economy that are directly or indirectlyaffected by the foreign exchange rate such as, economic growth,merchandise trade, capital flows, inflation, interest rates, and theinfluence of the local currency on the international stage. Thus, itis in the interest of the government to intervene when the foreignexchange market has a lot of downward or upward pressure based on thebest advice of a foreign exchange officer to keep it from negativelyaffecting these aspects.

Question2: The rationale for choosing Mexico

Mexicois among the countries that recently adopted the floated exchangerate regime after the failure of the fixed regime in the mid-1990s. During that time, the Mexican economy was and still is merging toearn its place as a strong economy in Latin America. After years offailure through the fixed regime, Mexico has come out as a notablecase study for other economies on the importance and pros of avariable exchange rate regime. The analysis also takes cognizance ofthe current monetary framework in the country in relation to themodern economy with the specific intention of advising the governmenton how the country should continue improving the exchange rate regimetowards a more flexible market. Observing the behavior of theeconomy is also another very important paradigm that informs theadvice to give the Secretary of the Treasury on the decisions to takeso that the country gets the best out of its recent developments onthe foreign exchange market.

Mexicois also the only country that has had recent intensive governmentinvolvement in streamlining the financial sector. Considering thatthis discussion is about the advice that a foreign exchange providesto the Secretary to the Treasury, it will be plausible to use Mexicoas an example of the role of government in fixing the fragilitiesthat affect the financial sector especially commercial banks as aresult of pressures arising from the foreign exchange market. Forexample, some of the actions that the Mexican treasury took to fixthe financial sector during the crisis included strengthening thefinancial sector through strict regulations and supervisions, and theintroduction of a viable hedging market that uses financialinstruments to mitigate pressures arising from the foreign exchangemarket.

Question3: Foreign exchange decisions that the Mexican population

Before describing the decisions, a brief overview of the currentMexican foreign exchange market is vital. In Mexico, the mainparticipants on the foreign exchange market are, the Treasury(referred to as the ministry of finance) through the central bank,all the commercial banks that operate in the economy, and the majorfinancial corporations that have a huge stake in the money markets. The Mexican Peso is accepted internationally including North America,the Pacific Asia, South East Asia, and China. The market also enjoysa great deal of modern technology that has made it easier forinformation to be shared across the market. There are differentwebsites through which traders make Foreign exchange transactions.Thus, the decisions discussed below factor in the position that theMexican foreign exchange market takes on the international foreignexchange markets and that of Latin America.

Aforeign exchange decision to ease inflation: The Mexican economy isalso prone periodic inflationary pressure like most open economies. Inflation is also a very common phenomenon in the Mexican economybecause the country relies heavily on oil as a major source ofenergy, which is imported on a large scale. Imported inflation iscommon. When the Mexican Peso devalues by say 20%, the effect is anincrease in the general price of imported commodities by almost thesame percentage. The increase degenerates from the fact that it willneed a revaluation of the Peso by the same percentage so that theprice of imported commodities falls to the original price. Theforeign exchange advisor will then advise the treasury to have moredollars into the economy through reducing the central bank reserverequirement for commercial banks. Alternatively, having more Pesosinto the economy may cause the same effect. However, using the dollarin this decision is plausible because it is the international pricein the oil market. Imported inflation can cause a rise in thegeneral rate of inflation because in a free market economy likeMexico, local producers will also set higher prices if the cost ofoil goes up. They can only reduce the prices if they are cushionedby a currency revaluation.

Thesecond decision on foreign exchange is on interest rates. Sometimesthe Mexican Peso becomes so strong that it exerts on a drag on theentire economy. In these circumstances, the foreign exchange ratebecomes an impediment to monetary decisions that seek to tighten theeconomy to ease pressure on the economy. When the Peso is strong ithas the same effects as having high interest rates in the economy. High interest rates discourage investors because they make the costof capital unaffordable.Furthermore, a very strong currency inamid very high interest rates attracts foreign investors who are keento make quick and high returns. The “hot money” further pushesthe Peso up making everything worse for the economy. The keydecision that would mitigate these circumstances in the Mexicaneconomy is again to considerably devalue the Peso so that all theupward pressures originating from the foreign exchange market areeliminated.

References

Andersen, T. G., Bollerslev,T., Diebold, F. X., &amp Vega, C. (2002). Microeffects of macro announcements: Real-time price discovery in foreignexchange (No.w8959). National bureau of economic research.

Domaç, I., &amp Mendoza, A.(2004). Is there room for foreign exchange interventions under aninflation targeting framework? Evidence from Mexico and Turkey.Evidence from Mexicoand Turkey (April 22, 2004). World Bank Policy Research WorkingPaper, (3288).

Mohanty, M. S., &amp Turner,P. (2006). Foreign exchange reserve accumulation in emerging markets:what are the domestic implications?. BISQuarterly Review, September.

Obstfeld, M., Rogoff, K. S., &ampWren-lewis, S. (1996). Foundationsof international macroeconomics(Vol. 30). Cambridge, MA: MIT press.

Rodrik, D. (2006). The socialcost of foreign exchange reserves. InternationalEconomic Journal,20(3),253-266.

Reinhart, C. M. (2000). Themirage of floating exchange rates. AmericanEconomic Review,65-70.

Saunders, A., Cornett, M. M.,&amp McGraw, P. A. (2006). Financialinstitutions management: A risk management approach(Vol. 8). McGraw-Hill/Irwin.