peso problem

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The tendency in countries with a past history of high inflation for interest rates to remain higher than abroad. This problem occurs where experience of inflation and currency depreciation in the past has led to expectations that the future will be similar. Even if such a country succeeds in stabilizing its price level and exchange rate, until market expectations adjust to this new stability, interest rates remain higher than in countries whose currencies are expected to remain stable. An interest premium is needed to compensate both domestic and foreign investors for the risk they feel exposed to when holding a currency whose stability they mistrust. The name ‘peso problem’ links it to Mexico, but many other countries, including the UK, have suffered from the same problem.

Subjects: Economics.

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