Mexico
Table of Contents
Overview
Mexico’s highly industrial economy is the second largest in Latin America, with a nominal GDP of over $1.5 trillion USD. It is the third most populated country in the Americas, with 133 million residents.
Mexico’s economy is characterized by manufacturing and international trade. Approximately 21% of National GDP comes from the manufacturing industry. Key components of the manufacturing sector include the automotive, aerospace, electronics, oil, consumer product, tourism, food and agriculture industries. Mexico has a strong trade relationship with the United States. After the USMCA free trade agreement and the US-China trade wars, Mexico is the United States’ top trade partner, exporting over $500 billion USD worth of goods annually. Approximately 80% of Mexican exports are sold to the United States.
Further, Mexico is classified as an Upper Middle Income economy. However, it faces challenges with high levels of income inequality, underemployment, and a large informal sector. The Gini Index, a measure of income inequality, is 43.5 (the Gini Index goes from 0 to 100, where 100 represents maximum inequality). Some difficulties which may contribute to this include high levels of corruption, as well as ongoing drug-related violence.
Macroeconomic Dashboard
AD-AS Analysis
Policy Change #1 (Consumer Sentiment circa 2016)
Following the November 2016 U.S. presidential election, Mexican consumer sentiment declined sharply as measured by INEGI’s Consumer Confidence Index, driven by widespread uncertainty over President-elect Trump’s campaign promises to renegotiate NAFTA, impose tariffs on Mexican goods, build a border wall, and restrict remittances, all of which posed direct threats to the Mexican economy given that roughly 80% of its exports go to the United States and remittances represent a significant share of household income, particularly for lower-income families. This shock caused Mexican households and businesses to pull back on spending and investment decisions, reducing consumption and shifting aggregate demand leftward, and was compounded by a sharp depreciation of the peso in the immediate aftermath of the election, which further eroded purchasing power and deepened the sense of economic vulnerability among Mexican consumers and firms, with the policy primarily affecting aggregate demand rather than aggregate supply since productive capacity and long-run potential output remained unchanged.
Real-World Data Comparison
We present a table displaying our expected findings compared to the findings illustrated in real-world macroeconomic data. Our macroeconomic data were collected from the Federal Bank of St. Louis FRED data collected on the Mexican economy. Overall, we see that the models do a good job predicting short-run changes in the economy, but not long-run changes in the economy.
| Variable | Short Run (Expected) | Short Run (Real) | Long Run (Expected) | Long Run (Real) |
|---|---|---|---|---|
| Price (P) | ↓ | ↓ | ↓↓ | No change |
| Output (Y) | ↓ | ↓ | No change | ↑ |
| Interest Rate (r) | ↓ | ↑ | ↓↓ | ↑↑ |
| Investment (I) | ↑ | ↑ | ↑↑ | No change |
| Consumption (C) | ↓ | ↓ | ↓↓ | No change |
| Total Workers (N) | ↓ | No change | No change | No change |
| Real Wages (W/P) | ↑ | No change | No change | No change |
Policy Change #2 (Interest Rates 2017-2019)
From 2017 to 2019, Banco de México raised its benchmark interest rate repeatedly from roughly 5.75% to 8.25% in an effort to combat surging inflation, which peaked near 6.8% in late 2017 and was well above the central bank’s 3% target, with the inflationary pressure stemming largely from the January 2017 gasolinazo, a sudden liberalization of government-controlled fuel prices that caused gasoline prices to rise by as much as 20% overnight and fed through to broader consumer prices across the economy. By tightening monetary policy, Banco de México shifted the LM curve leftward, raising real interest rates and increasing the cost of borrowing for both firms and households, which reduced investment spending and credit-financed consumption and shifted aggregate demand leftward as the central bank prioritized price stability over short-term economic growth, with the policy primarily affecting aggregate demand rather than aggregate supply since the tightening was aimed at cooling spending rather than altering the economy’s productive capacity.
Real-World Data Comparison
The table below demonstrates the differences between the predicted changes and actual changes in macroeconomic indicators. Again, we collected our macroeconomic data from the Federal Reserve Bank of St. Louis FRED. We observe, again, that the macroeconomic models perform well when predicting short-run outcomes. In this case, the long-run outcomes are mostly correct, except for price and real output.
| Variable | Short Run (Expected) | Short Run (Real) | Long Run (Expected) | Long Run (Real) |
|---|---|---|---|---|
| Price (P) | ↓ | ↓ | ↓↓ | No change |
| Output (Y) | ↓ | ↓ | No change | ↑ |
| Interest Rate (r) | ↑ | ↑ | No change | No change |
| Investment (I) | ↓ | ↓ | No change | No change |
| Consumption (C) | ↓ | ↓ | No change | No change |
| Total Workers (N) | ↓ | ↑ | No change | No change |
| Real Wages (W/P) | ↑ | No change | No change | No change |
Discrepancies and Interpretation
Overall, we observed that the models did a good job predicting short-run outcomes, but the long-run outcomes appeared more random. We believe this is due to constant changes in the macroeconomy. Countries typically experience slow, constant growth, which we do not take into account when predicting no change for price and real output in the long run. Further, countries experience exogenous shocks all the time, making it difficult to identify a single “long-run” time period in real-world data.
We believe this is partially due to limitations in the AD-AS model. One large limitation is the exclusion of interactions with foreign economies. A large part of Mexico’s economy is made up of trade and remittances, which can be affected by constant exogenous shocks which are not represented in this model. For example, during the 2018 US-China trade wars, the United States and China mutually escalated tariffs, which diverted a large amount of trade from China to Mexico. This shock to the Mexican economy can not be represented in the AD-AS model.
Section 1: Extreme Macroeconomic Event - Mexico Peso Crisis (1994-1995)
Event Description and Historical Context
On December 20, 1994, the newly inaugurated government of President Ernesto Zedillo announced a 15% devaluation of the Mexican peso, a currency that had been tightly pegged to the U.S. dollar for years. The move immediately backfired. Investor confidence collapsed, capital fled the country, and the peso lost nearly 50% of its value within weeks, earning the episode the name “Tequila Crisis.” The crisis did not emerge from nowhere. Through the early 1990s, Mexico had run a current account deficit of roughly 7–8% of GDP financed by volatile short-term foreign inflows, allowed its foreign exchange reserves to quietly drain from $20 billion to under $6 billion, and accumulated nearly $29 billion in tesobonos, dollar-indexed government bonds that would become catastrophically expensive if the peso fell.
The political environment made a fragile situation worse. In 1994 alone, Mexico experienced the Zapatista uprising in Chiapas, the assassination of presidential candidate Luis Donaldo Colosio, and the assassination of the PRI’s secretary-general, each triggering fresh rounds of capital flight. Simultaneously, the U.S. Federal Reserve raised interest rates six times that year, pulling global capital toward dollar assets and away from emerging markets. By the time the Zedillo government attempted the controlled devaluation in December, reserves were nearly exhausted and the conditions for a full-blown crisis were already in place
Macroeconomic Impacts
The crisis struck every major macroeconomic variable at once. Real GDP contracted by approximately 6.2% in 1995, one of Mexico’s worst recessions of the 20th century, as industrial production collapsed and domestic credit dried up. Inflation surged from around 7% in 1994 to over 52% in 1995 as the cheaper peso drove up import prices, devastating middle-class households carrying peso-denominated mortgages. Official unemployment nearly doubled to over 6%, and real wages fell by an estimated 20–30% in a single year, with the informal sector absorbing many displaced workers at far lower incomes.
The shock propagated through the economy through several reinforcing channels. The peso’s collapse worsened government and private-sector balance sheets simultaneously, since both carried dollar-linked obligations that roughly doubled in peso terms overnight. To arrest the currency’s fall and combat inflation, the Bank of Mexico raised short-term interest rates to over 80%, which choked credit and deepened the recession further. The crisis also spread internationally through what became known as the “Tequila Effect,” triggering capital outflows and banking stress in Argentina, Brazil, and other emerging markets as investors repriced risk across the entire asset class.
Policy Response and Aftermath
The crisis was resolved through an unprecedented international rescue. The Clinton administration assembled a $50 billion bailout package in early 1995, comprising $20 billion from the U.S. Exchange Stabilization Fund, $17.8 billion from the IMF, and $10 billion from the Bank for International Settlements. In exchange, Mexico accepted strict austerity conditions, raising its value-added tax from 10% to 15% and cutting public spending sharply. The Bank of Mexico abandoned the exchange rate peg entirely, allowing the peso to float freely, while the government launched the FOBAPROA bank rescue program to absorb non-performing loans and prevent a complete financial system collapse, a bailout that ultimately cost an estimated 15–20% of GDP.
Recovery came faster than most expected. Real GDP growth returned in 1996 and exceeded 6% by 1997, driven by a surge in exports made competitive by the weaker peso and accelerated by NAFTA’s open U.S. market. Mexico repaid the U.S. emergency loan ahead of schedule in January 1997. The crisis also left lasting institutional changes: the Bank of Mexico gained formal independence, Mexico adopted a permanent floating exchange rate, and the IMF developed new emergency lending tools in response to the episode. The longer-term costs, however, were real. Real wages took years to recover, the FOBAPROA bailout remained politically toxic for a decade, and the crisis deepened Mexico’s structural dependence on the U.S. economy.
Section 2: Economic Growth
Overview of Growth Patterns
Overall, Mexico’s Real GDP and GDP per capita has steadily grown over time. Mexico is particularly characterized by stagnant economic growth, averaging 2% growth on average. Most recently, the Mexican economy grew by 1.4% between 2024 and 2025. The periods of rapid growth usually follow periods of economic decline. Unsurprisingly, changes in Real GDP are heavily correlated with changes in GDP per capita, so we can talk about changes in either as growth or economic decline without loss of generality. In particular, the economy crashed in 1994-1995, then grew between 1995-2000. The early 2000s experienced stagnant growth until the 2008 recession, which was followed by another period of steady economic growth until 2020. Since 2020, the economy has recovered from the pandemic and is steadily growing once again.
Drivers of Economic Growth and Interpretation
One large driver of Mexican economic growth has been its trade relationship with the United States. NAFTA was established in 1994, which eliminated many tariffs and made trade less costly. As a result, Mexico was able to invest more money into manufacturing sectors, resulting in sharp increases in Real GDP as soon as the economy recovered from the 1994 Peso Crisis. However, research finds that the introduction of free trade in Mexico led to a causal increase in wage inequality, suggesting that the richest Mexicans benefited the most from this policy.
Nonetheless, we note that increases in GDP are strongly correlated with increases in Net Exports, suggesting this is one of the largest drivers of the Mexican economy. In particular, the automotive industry has experienced significant growth.
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