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Lecture: Seven Sects of Macroeconomic Error, Part II

The Brookings Institution Puts the Brookings Papers on Economic Activity Online for Free

Karen Dynan emails:

We are now making the entire journal --- which includes the current conference papers as well as the full 40+ years of archived articles -- available online for free. The link is here: Justin Wolfers (who is co-editor of BPEA) is doing his part to promote this news today on the Freakonomics blog...

For example, here is one of the best: Rudiger Dornbusch and Alejandro Werner (1994), "Mexico: Stabilization, Reform, and No Growth"

IN THE SECOND HALF of the 1980s... Mexico was coming to be viewed as a showcase of successful stabilization and economic reform, institutional stability, and financial predictability. Mexico was becoming what Chile already had become and what all of Latin America hoped to be.... By April 1994, the sharp upturn in interest rates, arising from speculative attacks on the peso, suggested that a far too optimistic view may have been taken of Mexico's future.The Mexican economy had come to a virtual standstill. Per capita income is now far below what it was in 1980.... [A]ny positive growth that may occur in 1994 will have been fueled by fiscal expansion not by strength in the real economy.

This paper argues that Mexico suffers from a failure to accompany the stabilization of inflation... and... economic reforms with not only true political reform but also true economic progress. The stabilization strategy has led to an overvaluation of the exchange rate, a precarious financial situation, and a lack of growth....

Less sanguine observers argue that the financial flows may be fragile, however. The flows are financing not only investment but also a high level of consumption and intermediate goods imports, with the large external deficit dampening demand for domestic goods. For full employment to occur, then, crowding-in is required (through an increase in the demand for domestic production). According to this argument, trade liberalization, which was an important part of recent reform, should have been accompanied by real depreciation not appreciation. To a large extent, we agree real depreciation is needed to improve the long-term economic prospects of Mexico and secure the benefits of economic reform...


President Carlos Salinas de Gortari is rightly acknowledged for the sweeping reforms in Mexico, but he left two loose ends. The first was postponing real democracy in favor of another six years of technocratic rule. The other was overvaluing the currency. For Salinas, inflation was the primary issue, just as it had been in Chile in the late 1970s. In his own words,

We must bring inflation down to a one-digit level this year. Some say, why don't you relax your inflation goals a bit so we can have better growth rates? And I respond: There is no trade-off between inflation and growth.

The evidence of the past few years contradicts his statement. Disinflation with overvaluation is a temporary device that ultimately causes great damage. In Mexico, that sad ending lies ahead unless the currency is devalued.