Argentine Financial Crisis

The Argentinean economy was hit hard by the crisis of 1999-2002 when the national currency plummeted. As prices needed daily readjustment, business was hurt by the immense instability of the currency. To cope with the former financial troubles, the nation should introduce a string of measures that will help it keep its currency in good shape.

One of these measures is dollarization of the economy. Dollarization can be official or unofficial, but in any case it means extensive use of dollars in exchange of the national currency. Reliance on the relatively stable currency that the US dollar has been for years is helpful to fragile emerging economies that are in heavy dependence on the stability of their currencies.

A successful example of official dollarization is Panama

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This little Central American state is the only nation in the developing world that passes a three-part test of currency stability: “no years of inflation over 20 percent, loss of value against the dollar of no more than 25 percent, and no restrictions on buying foreign currency since the end of the gold standard” (Mack, 2000). This test is passed by the US but is not possible to pass for many developing nations. Dollarization could help the Argentine, too, to increase the stability of its economy and shield it from future shocks.

Another important issue is to return the independence of the central bank, vesting this institution with the authority to make independent decisions. It can also be helpful if the national central bank can be given the authority to curb inflation, a prerogative that be embodied in legislation. To ensure that the central bank adequately performs its role, the nation’s policy-makers needs to establish clear divisions between the central bank and the government. The government will be responsible for articulating economic policy, including the overall strategy and goals for monetary policy, whereas the executives of the central bank will make monthly decisions concerning the policies on inflation targets. These decisions have to be made by experts, completely independent of government structures. In this case, decision-making on monetary matters will be outside of the competence of government officials.

In addition, the government needs to adopt consistent and stringent fiscal and monetary policies. Government debt has to be kept at adequate levels; otherwise, its unlimited expansion can undermine the national economy. Huge government spending was one of the forces that precipitated the Argentine’s economic crisis in the late 1990s, and this mistake has to be avoided in the future. As a result of prudent fiscal policies, the government can be able to harness debt growth and ideally start repayment of debt already accumulated by this point.

Responsible fiscal policy should be complemented by wise monetary policies

If a government spends too much, this leads to budget deficits, which in turn “may put pressure on the monetary authorities to monetize the debt” (Mishkin, 2002, p. 2). This monetization can trigger explosive money growth and consequently lead to inflation. To avoid the situation, the government should be careful with money supply, remembering that it can trigger a new crisis.

Besides, the nation can reconsider its policy concerning the exchange rate between the peso and the US Dollar. One of the primary reasons of the Argentinean financial crisis was the decision of the government in 1991 to peg the value of the peso to the US dollar, allowing citizens to convert any amount of pesos into dollars, thus ensuring the peso’s ‘convertibility’. Since the value of the peso was set at levels too high, the crisis entailed the runon on banks. Allowing the peso to fluctuate against the dollar would lead a more automatic realignment of the exchange rates between the two currencies. A more liberal exchange rate would make the adjustment more spontaneous. As a result, Argentinean citizens would be less tempted to run on banks in order to convert their pesos into dollars, knowing that exchange rates fluctuate in response to the purchasing power of the currency.

To address inflation in the early stages, the government can adopt an inflation target that will serve as an explicit nominal anchor, such as a fixed exchange rate or a money-growth target adopted in Germany. Nations that have adopted the annual inflation target including New Zealand, the US, Canada, Australia and others, have demonstrated superior ability to overcome inflation and keep it in check (Mishkin, 2002, p. 4).

The adoption of an inflation target can help the central bank deal with price and output fluctuations

For example, “because a decline in aggregate demand also leads to lower-than-expected inflation, a central bank is able to respond with a monetary easing” (Mishkin, 2002, p. 4). Therefore, Argentina, by setting an inflationary target, will be able to foresee and curb inflation, as well as prevent deflation.

One cannot overestimate the importance of political stability in warding off economic crises. In Latin American nations, frequent changes of political leadership have not only caused civil unrest that dampens investors’ enthusiasm for the nation, but have also resulted in inconsistent economic policies. As in the case of the Argentinean economic crisis, the results of fallacious economic policies are often cleared by a new leadership that has little understanding of the current economic situation. Consolidation of society, promoting fair and democratic elections will help ensure political stability. This stability, in turn, can be instrumental in addressing the issues of corruption or ineffective or discriminatory economic policies. It will also help created a more transparent environment for political and economic decision-making.

The frequent change of leadership can make the politicians focus on short-term results instead of pursuing long-term objectives. The result can be disastrous for the economy. An example is the so-called time inconsistency problem when politicians “try to exploit the short-term tradeoff between employment and inflation to pursue short-term employment objectives” (Mishkin, 2002, p. 4).

In this case, the long-term effects can be seriously negative, resulting in a financial crisis among other things. However, a government that expects to soon lose power to the next government will often want to leave behind the impression of a rise in income levels and boosted employment, and so will choose to purse the path of increased employment and growth at the expense of inflation. Political stability will reduce the incentives for politicians to indulge in such policies that produce good outcomes only over the short term.

Finally, the nation should think about adopting a stable tax environment that would help avert future financial troubles. The crisis of 1999-2002 was spearheaded by massive tax evasion that resulted in money laundering and capital flight to offshore banking institutions. The government in the future has to take precautions against such harmful trends. Creating a stable and transparent tax legislation and enforcing it effectively can help promote financial stability and channel the funds into the budget. This would supply coverage of government spending, offsetting it in order to avoid deficits. In turn, this would create prerequisites for filling the government budgets and refraining from taking on more debt, as well as facilitate the repayment of debt.

Argentina can prevent future crises by pursuing a combination of these policies. It is important to apply several accompanying policies to achieve an optimal result. First of all, the leadership of the nation has to recognize its responsibility to citizens for keeping the economic policies well-balanced and sound. Orienting the political decision-making toward goals that cover a long-term horizon will also help make Argentina’s economic prospects look brighter.

References

1. Mack, C. (2000, January). Basics of Dollarization. Joint Economic Committee Staff Report, Office of the Chairman. Retrieved April 14, 2006, from http://users.erols.com/kurrency/basicsup.htm
2. Mishkin, F.S.  (2000). What Should Central Banks Do? Retrieved April 14, 2006, from Federal Reserve Bank of St. Louis website at: http://research.stlouisfed.org/publications/review/00/11/0011fm.pdf

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