Economic Fundamentals and Self-Fulfilling Crises: Some Evidence from Mexico

This paper considers a model of debt stabilitisation under a fixed exchange rate in which a currency crisis can develop as the result of self-fulfilling speculation, following a bifurcation in the behaviour of economic fundamentals. Based on this theoretical framework and by exploiting the test developed by Jeanne (1997), this paper provides evidence that self-fulfilling speculation was at work in the 1994 Mexican crisis. In terms of fundamentals, we show that the critical variables in generating the Mexican crisis were the fast rise in the US$-denominated public debt (tesebonos), the appreciated real exchange rate and the small rises in unemployment and primary deficit.