Content area
Full text
By DOMINGO F. CAVALLO AND JOAQUIN A. COTTA *
Almost six years have passed since Argentina introduced a currency board system called "convertibility." It consists of a one-for-one peg between the peso and the U.S. dollar and full backing of the monetary base with international reserves. In spite of its resounding success in reducing inflation, there is still a considerable degree of skepticism in the world, although not so much in Argentina, about whether convertibility is a suitable monetary arrangement for the long run. Prestigious economists have argued that convertibility was a useful tool to stop hyperinflation in Argentina but that it is not suitable for countries facing less dramatic conditions ( see John Williamson [ 1995] and the speeches by Max Corden, Stanley Fischer, and Williamson in World Bank [1997]). According to them, even Argentina should think of abandoning this system as a way to promote economic growth and higher employment.
International institutions like the International Monetary Fund and the World Bank have been extremely supportive of convertibility in Argentina. But in private they are concerned about what Sebastian Edwards, former World Bank chief economist for Latin America, has called the "exit problem," (i.e., how a country like Argentina can get out of the commitment to a fixed exchange rate without risking price stability).
. Historical Background
In July 1989 the Argentine economy was in shambles. Per capita GDP was 10 percent lower than in 1980, and social indicators had deteriorated dramatically. The fiscal deficit was 7.6 percent of GDP, and the gross investment rate was only 14 percent of GDP. Years of fiscal and monetary indiscipline had resulted in hyperinflation. Street riots and social chaos forced then president Raul Alfonsin to transfer power to newly elected president Carlos Menem five months before the normal time. After 18 months of political hesitation, the Menem government finally decided to tackle the problem at its root and launched the Convertibility Plan. By the end of 1991 annual inflation was below 20 percent, and GDP was growing at 9 percent per year. Inflation continued to fall until it converged to international levels in 1994. A faster convergence was not possible due to the strength of aggregate demand between 1991 and 1993. At the same time, the...