Tag: Interest rates and exchange rates

Solved Problem: The Mexican “Super Peso”

A food market in Mexico. (Photo from mexperience.com)

Supports: Macroeconomics, Chapter 18, Economics, Chapter 28, and Essentials of Economics, Chapter 19.

In September 2023, an article in the Los Angeles Times discussed the effects on Mexico of the “’super-peso,’ as the Mexican currency has been dubbed since steadily gaining 18% on the dollar during the last 12 months.” The article focused on the effects of the rising value of the peso on people in Mexico who receive U.S. dollars from relatives and friends working in the United States. Many of the people who receive these payments rely on them to buy basic necessities, such as food and clothing. An article in the Wall Street Journal on the effects of the rising value of the peso noted that: “The peso’s strength has helped curtail inflation ….” 

  1. Briefly explain what the Los Angeles Times article means by the peso “gaining” on the U.S. dollar? Does the peso gaining on the dollar mean that someone exchanging dollars for pesos would receive more pesos or fewer pesos? 
  2. As a result of the rising value of the peso would people in Mexico receiving dollar payments from relatives in the United States be better off or worse off? Briefly explain. 
  3. Why would the increasing strength of the peso reduce the inflation rate in Mexico?
  4. The Los Angeles Times article also noted that: “The Bank of Mexico’s benchmark interest rate of 11.25% is more than double the U.S. Federal Reserve target …” Does this fact have anything to do with the increase in the value of the peso in exchange for the dollar? Briefly explain. 

Solving the Problem

Step 1:  Review the chapter material. This problem is about the effect of fluctuations in the exchange rate and the relationship between interest rates and exchange rates, so you may want to review Macroeconomics, Chapter 18, Section 8.2, “The Foreign Exchange Market and Exchange Rates,” or the corresponding sections in Economics, Chapter 28 or Essentials of Economics, Chapter 19.

Step 2: Answer part a. by explaining what it means for the peso to be “gaining” on the U.S. dollar. The peso gaining on the dollar means that someone can exchange fewer pesos to receive a dollar. Or, alternatively, someone exchanging dollars for pesos will receive fewer pesos. 

Step 3: Answer part b. by explaining why people in Mexico receiving dollar payments from relatives in the United States will be worse off because of the rising value of the peso. People living in Mexico needs pesos to buy food and clothing from Mexican stores. Because people will receive fewer pesos in exchange for the dollars they receive from relatives in the United States, these people will have been made worse off by the rising value of the peso. 

Step 4: Answer part c. by explaining why the increasing strength of the peso will reduce inflation in Mexico. A country’s inflation rate includes the prices of imported goods as well as the prices of domestically produced goods.  A stronger peso means that fewer pesos are needed to buy the same quantity of a foreign currency, which reduces the peso price of imports from that country. For example, a stronger peso reduces the number of pesos Mexican consumers pay to buy $10 worth of cucumbers imported from the United States. Falling prices of imported goods will reduce the inflation rate in Mexico. 

Step 5: Answer part d. by explaining why higher interest rates in Mexico relative to interest rates in the United States will increase the value of the peso in exchange for the U.S. dollar. If interest rates in Mexico rise relative to interest rates in the United States, Mexican financial assets, such as Mexican government bonds, will be more desirable, causing investors to increase their demand for the pesos they need to buy Mexican financial assets. The resulting shift to the right in the demand curve for pesos will cause the equilibrium exchange rate between the peso and the dollar to increase. 

Sources:  Patrick J. McDonnell, “Mexico’s Peso Is Soaring. That’s Bad News for People Who Rely on Dollars Sent from the U.S.,” Los Angeles Times, September 5, 2023; and Anthony Harrup, “Mexico’s Peso Surges to Strongest Level Since 2015,” Wall Street Journal, July 13, 2023.