Inflation Remains Under Control in Mexico

The United States decided not to renew the free trade agreement with Mexico and Canada, instead replacing it with an annually reviewed agreement, which eliminates one of its main virtues: reducing uncertainty for medium-term investments. Meanwhile, violence and corruption continue to affect businesses and consumers in the country, and institutions that took decades to build are being destroyed, eliminated, or modified. The fiscal deficit remains high, and the public debt has doubled in less than a decade.

International rating agencies have reduced their opinion on the Mexican government’s ability to pay its debt, putting the so-called Investment Grade at risk, which could lead to a significant withdrawal of foreign financial investment. However, inflation remains under control at low levels, with an annual rate of 3.37% in June, although above the official target.

The value of the peso with respect to the dollar does not necessarily reflect the state of the country’s economy. The same applies to inflation, which is often driven by people’s fears rather than the actual economy. In reality, both the value of the peso and inflation are the result of the phenomenon of supply and demand.

If there is an abundance of buyers for a product or service and the quantity available in the market remains the same or decreases, then prices rise. In the case of inflation, the demand for goods and services increases, and if the supply does not keep pace, the difference is covered by higher prices.

The main cause of this imbalance between supply and demand is the increase in monetary liquidity, i.e., excessive money issuance by the central bank. However, the Bank of Mexico is autonomous from the Executive Power, as is the case in most developed countries, and does not issue money without proper backing, nor can it finance the government.

In simple terms, there is no runaway inflation in the country because the central bank fulfills its purpose. Therefore, the deficit in public finances does not add demand to the entire economy, as it is not financed by the central bank, i.e., money is not printed to be spent. If the government increases its spending, it must either raise its income or increase its debt, which means withdrawing liquidity from the economy.

Believing that social programs increase inflation is incorrect because to grant them, taxes must be raised or debt issued, which increases interest rates, harming other sectors or businesses, reducing production and employment. The relative strength of the peso is due to the fact that there is a greater influx of dollars than outflows, i.e., there is an abundance of foreign exchange and low demand for it, resulting in a lower price.

The situation is due to various reasons, including the preference for acquiring financial instruments with higher interest rates than in investments in other countries, and the low demand for dollars due to recession in the economy or higher unemployment. One of the first effects of the strong peso is the reduction in the profit margins of exporters, harming an important sector of the economy.

The increase in government debt raises interest rates, which strengthens the peso, harming exporters, the tourism sector, companies with debt, and consumers who pay their credit card bills.