Question

Suppose that Mexico has a fixed exchange rate regime, and value of peso is fixed against the dollar. If, everything else constant, Mexico starts growing slower than US, how should the Mexico monetary policy react to maintain the fixed exchange rate regime?

Answer 1

1. As the key objective to monetary policy, Mexican government should focus on long term price stability as they had been rewarded for lowering inflation rates and also interest rates in the prior years and they must continue to do by maintaining proper stability in the economy.

2. Mr. Ortiz (Guillermo Ortiz Martínez)who once had been public finance minister of Mexico controlled the currency held by the bank and also the public which in turn helped the government to gain capital and also stabilize the exchange rate of Peso and the Dollar. This should also be maintained consistently in the coming years.

3. The main challenge to Peso is to bring down the inflation rate as much a possible by adopting the rule of inflation targeting but the Mexican government is still discretionary.

4. Mexico should maintain international reserves in order to be sustained in fixed exchange rate regime.

5. The monetary authority should set a constant exchange rate against dollar and should be ready to either buy or sell the foreign exchange to maintain the current exchange rate.

6. Full dollarization is a system adopted wherein the currency of ones own country is made fixed against the rate of the dollar so that the supply of money is increased when foreign exchange is purchased which is valued at the fixed exchange rate and vice versa.

7. The main flaw would be the absence of lender of last resorts wherein the central bank wouldn't offer loans in times of financial stress which is debatable by the currency board.