Abstract
The rise and fall of Argentina's currency board illustrates the extent to which the advantages of hard pegs have been overstated. The currency board did provide nominal stability and boosted financial intermediation, at the cost of endogenous financial dollarization, but did not foster fiscal or monetary discipline. The failure to adequately address the currency-growth-debt trap, into which Argentina fell at the end of the 1990s, precipitated a run on the currency and the banks, followed by the abandonment of the currency board and a sovereign debt default. The crisis can be best interpreted as a bad outcome of a high-stakes strategy to overcome a weak currency problem. To increase the credibility of the hard peg, the government raised its exit costs, which deepened the crisis once exit could no longer be avoided. But some alternative exit strategies would have been less destructive than the one adopted.
Highlights
The rise and fall of Argentina’s currency board and the subsequent financial system collapse yield important lessons for the debate on exchange rate regimes for developing countries.1 As expected, the Argentine case has already generated an extensive debate on the causes and policy implications of the crisis.2 Current explanations, concentrate too much on the latest years and do not pay enough attention to the underpinnings of the currency board and to its implications for the financial system and the economy at large.In this paper, we study the Argentine experience from a perspective that links money and financial intermediation
Out of the ashes left by hyperinflation and financial disarray in Argentina in the 1980s, the one-peso-one-dollar rule of convertibility quickly restored the function of money as a store of value, thereby enabling a rapid regeneration of financial intermediation as reflected a steep growth of bank deposits and loans throughout 1999 (Figure 1)
The first relates to the practical limitations of a hard peg, in the case of countries that do not meet the conditions for an optimal dollar area
Summary
The rise and fall of Argentina’s currency board (a textbook model of a rigid exchange rate regime for more than 10 years) and the subsequent financial system collapse yield important lessons for the debate on exchange rate regimes for developing countries. As expected, the Argentine case has already generated an extensive debate on the causes and policy implications of the crisis. Current explanations, concentrate too much on the latest years and do not pay enough attention to the underpinnings of the currency board and to its implications for the financial system and the economy at large. We find support for an intermediate exit option: dollarization of existing financial contracts (“stock dollarization”) to respect the widespread use of the dollar as store of value, combined with “pesification at the margin” (for instance, via the consolidation of the existing pesos and quasi-monies into a new national currency) to exploit the use of the peso as means of payment and unit of account, which remained extensive and resilient throughout the convertibility period and even during the run.3 While this alternative would not have spared Argentina from significant banking system stress and even some individual bank failures, as debtors in the nontradable sector would have seen their balance sheets and payment capacity adversely affected by the real exchange rate correction, it might have provided a margin of nominal flexibility while avoiding a systemic financial collapse and the unnecessary destruction of property rights.
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