This study identifies the main factors that explain the recovery of the Mexican economy after the currency crisis of 1995. A growth decomposition exercise shows that export growth mitigated somewhat the effect of the crisis in 1995, but contributed only modestly to the recovery afterwards. The V-shaped behavior of fixed investment was the main factor behind the economic slowdown during the crisis and the strength of the subsequent recovery. Evidence for Indonesia, Korea, and Thailand also show that fixed investment explained a substantial portion of the reduction in economic growth during their recent crises. Econometric results show that fixed investment fell precipitously in 1995 as a result of both the negative income effect and the increase in the cost of capital caused by the sharp depreciation of the currency. However, this initial contractionary effects of the devaluation were followed by the dominance of the substitution effect in favor of tradables output, which, in the Mexican case, has a higher multiplier effect on investment than non-tradable output. We found no evidence of a ?confidence? effect associated with hikes in real interest rates (we did find it in the 1982-83 crisis, however). Also, we found support for the view that access to the U.S. financial market was a key feature of the recovery after 1995. A policy implication that emerges from the analysis is that, for countries like Mexico, currency depreciation, in spite of initial contractionary effects, appears as a better policy response to speculative attacks than interest rate defenses of overvalued currency levels.
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