Mexico's 1994 Exchange Rate Crisis Interpreted in Light of the Non-Traded Model

This paper attempts to make the case that a 2-sector model using the familiar traded non-traded distinction offers a reasonably successful empirical account of why Mexico needed to devalue its exchange rate in 1994. This model provides a way to define and measure disequilibrium in the exchange rate, and thus may be useful in assessing the likelihood of an exchange rate crisis in other developing countries. The results suggest that Mexico's exchange rate was about 25 percent overvalued on the eve of its 1994 crisis, but was much closer to equilibrium by the end of 1996. The approach in this paper is compared with other ways of assessing disequilibrium in the exchange rate, based on purchasing power parity or monetary models of the exchange rate.