Original Sin and the Exchange Rate Regime Debate: Lessons from Latin American and Transition Countries

Abstract

This paper discusses the implications of the collapse of Argentina's currency board arrangement on the debate about appropriate exchange rate regimes for emerging market countries (EMCs). It highlights the link between the inherent vulnerability of the EMCs (the so-called original sin hypothesis) and the operation of different exchange rate regimes. The structural weaknesses that typically make EMCs vulnerable to negative external shocks affect different currency regimes, as is illustrated using examples such as Argentina with its currency board arrangement, Brazil with its floating currency, and Panama with dollarisation. We contrast the experience of these countries with that of the accession countries in Central and Eastern Europe, which are much less sensitive to external shocks no matter what their exchange rate regime. It is argued that the main reasons for this difference are the smaller role of debt-creating flows in the financing of current account deficits, higher domestic savings, and – most important of all – the prospect of accession to the European Union and Economic and Monetary Union.