Financial Crisis, Fiscal Policy and the 1995 GDP Contraction in Mexico

Abstract

In 1995 Mexico experienced its largest contraction of GDP since the early 20th century. I propose a simple mechanism to partially account for the collapse of economic activity: distortions on consumption and leisure caused by fiscal policy. The contraction of GDP was preceded by a financial crisis. I argue that the response of the government had a significant impact on economic activity. Using a model with distortionary taxation and government consumption, I measure the impact of fiscal policy. Results show that fiscal policy has an important quantitative role in a theory of the contraction of output in Mexico in 1995.

Keywords: Financial crisis, Fiscal policy, GDP

JEL Classification: E32, E62