Dollarization in Argentina

Written shortly after Argentina’s government publicly floated the idea of abandoning the peso for the U.S. dollar, this Chicago Fed piece uses Argentina’s 1991-99 currency-board experience – already “quite close to being fully dollarized” – as a test case for the broader debate over monetary anchors: fixed versus flexible exchange rates internationally, and rules versus discretion domestically, of which “dollarization is the ultimate rule.” The authors first document how the 1991 convertibility law ended Argentina’s chronic hyperinflation (78 percent per month at its worst) by pegging the peso to the dollar under a currency board requiring the central bank to hold reserves equal to at least 100 percent of the monetary base, and how this stabilization coincided with faster growth, though the peg has twice come under speculative pressure – the 1995 “Tequila” crisis following Mexico’s devaluation, and the 1998-99 “Vodka-Caipirinha” turmoil following Russia’s default and Brazil’s devaluation. They then work through the mechanics of unilateral and bilateral dollarization, calculating that Argentina would permanently forgo seigniorage income worth roughly 0.2 percent of GDP annually – income that would instead accrue to the United States – while gaining a stronger commitment device than a currency board, since a currency board still leaves scope for a government to reintroduce discretion (via emergency decree or a change in law) that a full currency abolition would foreclose. The paper argues most of the commonly raised objections to dollarization – loss of a lender of last resort, loss of monetary policy independence – are less decisive than they first appear, given mechanisms Argentina has already built to substitute for both, and it closes with a rough cost-benefit calculation suggesting dollarization would be worthwhile if crises resembling the Tequila effect (a roughly 14 percent permanent output loss) recur with even modest probability. The authors are explicit, however, that they “do not reach a definite answer on whether Argentina should dollarize,” and caution that abandoning even the possibility of an independent monetary policy is a serious and irreversible step.

Marcelo Veracierto | Macro Paper Warehouse

Dollarization in Argentina