Dollarization in Argentina
Javier Milei, Argentina’s new president, has suggested that he might drop the peso and dollarize the economy. In this commentary, Scott Sumner argues that there might be a few reasons why dollarization could be a good solution to Argentina’s economic problems:
- Dollarization would solve the problem of hyperinflation: today inflation is over 140 percent.
- Dollarization is less risky than a currency board, but not completely free of risk: between 1991 and 2002 Argentina implemented a currency board and shortly after fell prey to costly speculative attacks. As a result, it suffered sharp increases in interest rates and recessions.
- The US dollar is currently quite strong therefore Argentina would be adopting the dollar at a point in time where large US dollar depreciation seems more likely than large currency appreciation.
It might seem odd that I view a strong dollar as a propitious time to dollarize, as it makes it more likely that Argentina’s inflation rate over the next few decades will slightly exceed the US level. If the dollar were currently weak, then Argentina might be expected to experience slightly lower inflation than the US (as the dollar strengthened.) In fact, Argentina has far more to fear from a few years of negative 1% inflation than from a few years of 5% inflation. Indeed, given their current triple-digit inflation rate, even a 5% inflation rate would seem like price stability to the Argentine public.
Dollarization for Argentina?
By: Scott Sumner – Bentley University
Dollarization when there is shortage of foreign reserves
In this paper, Caravello et al. study the transitional dynamics induced by dollarizing an economy that has an initial shortage of dollars much like Argentina has. They use an open monetary economy model with both tradable and non-tradable goods and consider both flexible prices and nominal rigidities. The country is limited in its borrowing capacity but can save freely abroad. The authors argue that right after the dollarization if dollars are initially scarce – due to limited reserves, limited credit, and low pre-existing dollar holdings- the economy undergoes a non-trivial transition towards its steady state. Their main result is that these dynamics resemble those of a “sudden stop”:
- As a result there will be a temporary drop in the consumption of tradable goods to accumulate foreign currency. In general, this requires a temporary drop in the real exchange rate, followed by a gradual real appreciation via positive inflation.
- With nominal rigidities the economy first falls into a recession. This is true even if all prices and wages are allowed to adjust flexibly on impact. This recession eventually gives way to a boom: the non-tradable sector transitions from the initial recession to a boom, then asymptotes to its steady state.
From a welfare perspective these dynamics are immediately costly, in the short-run, for two distinct reasons. First, we have the temporary drop in tradable consumption. Second, we have the inefficient fluctuations—recession followed by boom—in non-tradable consumption and employment.
Dollarization Dynamics
Authors: Tomas E. Caravello, Pedro Martinez-Bruera, Ivan Werning
From: MIT
