It seems almost certain that at some point in the near future the interest rates in the United States are going to rise. Interest rates have been hovering around zero for several years now, and it is only a matter of time until they rise at least a little bit.
When this happens, it will not only have an effect on the domestic economy, but on the international economy as well as we have seen in class through the international finance diagrams. One country in particular that has struggled in the past with movements in the US interest rates is Mexico. However, according to Agustín Carstens, Governor of the Bank of Mexico, the country is in a much better place to handle an increase in US interest rates, whenever that may occur.
Previously, Mexico has suffered from movements in the US interest rates as they were not well prepared and not able to handle these changes very well. In the past, the issue would have looked something like this: the US increases interest rates, which would result in a movement along the US NCO curve up and to the left. This would then cause the supply of dollars to shift to the left, which would increase the exchange rate in the United States and lower net exports. Simultaneously in Mexico, this would cause the NCO curve to shift to the right and the supply of pesos to shift to the right as well, which would decrease the exchange rate and increase net exports. While an increase in net exports may not seem like such a bad thing, this would put Mexico above their natural level of output and may begin to overheat their economy.
But now that Mexico is better prepared and will be able to handle such an increase in US interest rates, this sort of trouble should not occur. “Mexico is trying to have this process of increase in interest rates as orderly as possible,” Ramos-Francia (Mexico’s central bank deputy governor) said. When in fact the US does raise interest rates, Mexico should be able to respond in such a way to stay at (or return after a brief stray from) their natural level of output. In order to do so, after an increase from the US, Mexico could sell bonds domestically to decrease their money supply in order to increase their interest rates. This should result in a partial decrease in investment and a movement up and to the left along their new NCO curve which would shift the supply curve of pesos to the left (about halfway between the original and the intermediate curve), decreasing net exports partially and increasing the exchange rate, but not all the way back to the original level. In this way, Mexico would lower both net exports and investment part way in order to get back to the natural level of output.
While there have been some complaints from emerging markets about how much US policy can negatively affect their growth and progress, Augustín Carstens has said that “there are limits to international policy-making coordination. Developing-economy leaders ‘should take policies in advanced economies as given’ and should ‘deal with their own problems’ through their own powers.”
In saying this, it seems that Carstens maintains a positive view that Mexico has reached a point where they have enough power that they can truly handle their own issues as they come along from movements in the US. This is obviously a good thing for both Mexico and the US, as the United States can make changes as they see fit (as we should) and Mexico will be able to respond accordingly.