The Argentine economy has a distinguished history littered with bouts of financial crises and economic turmoil resulting from failed economic stabilization programs that stretches as far back as the Baring Crash of 1890 - considered to be the world’s first full-fledge emerging market currency crisis. For example, by some accounts, Argentina has had as many as eight major episodes of currency crises since 1970. Notwithstanding this litany of banking and economic debacles, the underlying causes for the failure of the numerous stabilization plans implemented has never been directly addressed - namely a combination of monetary indiscipline and fiscal indiscretion.
After years of experiencing hyperinflation in the thousands of percent per annum in the late 1980s, Argentina opted for an inflation based stabilization plan called the BB Plan in February 1989. This program, however, did not last very long as the Argentine authority financed their huge fiscal imbalances by printing money, and as a consequence of this the BB Plan collapsed seven months after it was implemented. The failure of the BB Plan, however, finally brought home the message that the Argentine authority lack any credibility in fiscal and monetary management and thus could not be trusted with managing domestic price levels without taking into account the fiscal promiscuity that has been the hallmark of most Argentine governments since 1890. To this end, an exchange rate based stabilization (ERBS) program - which removed the enticements of using money creation to finance the pervasive fiscal imbalances - was embarked upon in 1991.
Under the tutelage of the IMF2 and the leadership of Economy Minister Domingo Cavallo, Argentina instituted a Currency Board Arrangement (CBA) called the Convertibility Plan in April 19913, tying the Argentine peso to the US dollar at parity. The two main elements of this plans were the legal guarantee by the authorities of parity in conversion between the US dollar and the Argentine peso, and the backing of any expansion in the domestic currency by an equivalent increase in the foreign exchange reserves. Additionally, the monetary authorities granted the status of legal tender to the US dollar alongside the peso, thus allowing all domestic deposits and loans to be denominated in either currency. By introducing the CBA, the Argentine government effectively provided a nominal anchor that it hoped will break the longstanding domestic inflationary dynamics.
The main aims of this program were three-fold; firstly, by instituting a currency board arrangement, the Government of Argentina effectively signaled to investors its determination to surrender its undisciplined discretionary monetary policy instruments once and for all in favor of a more rigid rule-based monetary system4. Secondly, by allowing the circulation of the US dollar as legal tender, and the denomination of all debts and deposits in both currencies, the government demonstrated it strong political commitment to this regime by making the costs of reneging on this exchange rate based stabilization policy unbearably high. Finally, since the monetary authority can no longer monetize the fiscal deficits, the CBA would provide the much need discipline on the fiscal authority that have been lacking and return credibility to it economic management.Despite the straitjacket of this exchange rate based stabilization program and the early successes achieved by its implementation, within a decade of its implementation the program collapsed and resulted in the largest debt default in history. This paper, therefore, analyzes the circumstances surrounding the failure of this Argentine experiment with a currency board arrangement and the ensuing currency crisis of 2001. In doing so, the paper places this particular episode of exchange rate crisis into the broader context of the three generations of currency crises models under consideration in the literature and discuss...
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