Cato Policy Analysis No. 243 October 10, 1995

Policy Analysis

Mexico: Policy Failure, Moral Hazard,
and Market Solutions

by W. Lee Hoskins and James W. Coons

W. Lee Hoskins is chairman and CEO of the Huntington National Bank inColumbus, Ohio. He served as president of the Federal Reserve Bank of Clevelandfrom 1987 to 1991. James W. Coons is vice president and chief economistof the Huntington National Bank.


Executive Summary

For the fourth time in the past 20 years, the Mexican economy is in financial distress, largely because of bad monetary policies pursued by Mexican officials. The United States has responded in all four instances by lending money to the Mexican government as a short-term palliative. The cumulative result is a set of perverse incentives for Mexican officials and foreign investors that ensures the "crisis" will reappear on an even larger scale. In addition, the use of the Treasury's Exchange Stabilization Fund and the Federal Reserve to fund an administration's foreign ventures raises constitutional issues about separation of powers and undermines the principle of central bank independence.

There is no way to avoid the costs imposed by bad economic policies of the past. The best course for the future is to encourage market forces, stronger private property rights, price stability, and a floating exchange rate for the peso. Only by strengthening the institutions that produce such results will Mexico raise its standard of living.

Loans from the United States and international agencies such as the International Monetary Fund and the World Bank can arrest a crisis in the short run but are counterproductive in the long run. The new world order is one of market solutions, not government intrusion. To foster such outcomes the United States should pass legislation that eliminates the Treasury's ability to make foreign loans (through the ESF) and that removes the ability of the Federal Reserve (through swap lines) to extend credit to foreign central banks directly or indirectly by funding the ESF. Congress should also withdraw its support for the IMF and the World Bank.

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