Mexico tends to have much higher inflation than the United States and also much
ID: 2747810 • Letter: M
Question
Mexico tends to have much higher inflation than the United States and also much higher interest rates than the United States. Inflation and interest rates are much more volatile in Mexico than in industrialized countries. The value of the Mexican peso is typically more volatile than the currencies of industrialized countries, from a U.S. perspective; it has typically depreciated from one year to the next, but the degree of depreciation has varied substantially. What are some factors influencing this?
Explanation / Answer
Some factors influencing this are:
The high inflation in Mexico places continual downward pressure on the value of the peso.
The high interest rates in Mexico result from expectations of high inflation. That is, the real interest rate in Mexico may not be any higher than the U.S. real interest rate. Given the high inflationary expectations, U.S. investors recognize the potential weakness of the peso, which could more than offset the high interest rate (when they convert the pesos back to dollars at the end of the investment period). Therefore, the high Mexican interest rates do not encourage U.S. investment in Mexican securities, and do not help to strengthen the value of the peso.