3. Discuss what policy actions might have prevented or mitigated the balance of payments problem and the subsequent collapse of the peso.
- Efficient policy actions should have been taken in proper time, in order to prevent the BOP problem and subsequent collapse of the peso. A few of them are discussed below: - Mexico could have tightened its monetary policy in order to defend the peso from devaluating. Even though the Mexican central bank claims to have pursued such a policy, some analysts questioned this claim.
- Mexico could have abandoned the exchange rate peg and allow the peso to float. This policy would have eliminated the need for reserves to support the currency. Even though the peso would have sharply declined and fallen to a level near its long-run equilibrium, it would eventually have stabilized.
- The government could have devalued the peso. Ideally, the new value chosen by the government would have been consistent with the long run equilibrium, and hence, public confidence would have remained high enough to prevent a speculative attack on the new peg.
- Once the peso was devalued, nervous investors started shifting their funds out of Mexico. This resulted in a $4.5 billion loss in central bank reserves. Government should have prepared for such a major outflow of funds.

4. Derive lessons from the Mexican experience that may be useful for developing countries.
First, it is essential to have a multinational safety net in place to safeguard the world financial system from a peso type crisis. No single country can handle a potentially global crisis alone. In addition, the usually slow political processes cannot cope with rapidly changing market conditions. Second, Mexico depended on foreign capital to finance its economic development. Third, pegged exchange rates are often helpful in ending high inflation but become dangerous if they are