Comments

Alberto Ades: This paper critically examines the rise and fall of Argentina's currency board. The authors argue that while convertibility provided nominal stability and boosted financial intermediation, it failed to foster fiscal or monetary discipline. In particular, they emphasize that the failure to adequately address the currency-growth-debt (CGD) trap that Argentina experienced in the late 1990s precipitated a run on the currency and the banks, followed by the abandonment of the currency board and a sovereign debt default. De la Torre, Levy Yeyati, and Schmukler therefore see the crisis as a bad outcome of a high-stakes strategy to overcome a weak currency problem. They conclude by examining alternative exit strategies that would have been less destructive than the one adopted.

The authors provide a comprehensive and often quantitative analysis of the challenges faced by the currency board in 1998-2001. The effort is commendable, and it will likely be followed by additional work in this exciting and important area of research. My comments center on three specific areas that call for further refinement.

First, the authors characterize the situation that the authorities faced during the period as a CGD trap caused primarily by the economy's inability to adjust to external shocks. However, this CGD theory is hard to distinguish empirically from an alternative collective-suicide (CS) hypothesis. According to this theory, the Alianza government made an endless succession of policy and political mistakes that made the collapse of convertibility inevitable. Critical statements about convertibility by key Alianza leaders, the resignation of Vice President Carlos Alvarez, the forced resignation of Central Bank president Pedro Pou, attacks by the Finance Ministry on Central Bank independence, the modification of convertibility to peg the peso to a basket, statements by key Alianza politicians in favor of a debt restructuring and against globalization—these are just some of the political shocks that gradually eroded confidence in Argentina's economic institutions, fueled capital flight, and ultimately led to the collapse of the banking system and the peso. While the situation faced by the authorities in 1999 was far from ideal, it is hard not to speculate how much of the 2000-01 malaise was engineered by a government that never truly believed in the policies that circumstances forced it to defend. A more balanced discussion of these issues would benefit the paper.

Second, the authors argue, as do many economists, that flexibility (of labor markets and of primary public spending) is critical for fixed exchange rate regimes to work in the medium term. The same argument is applicable to a country considering dollarization. The authors note that given the difficulty in developing flexible labor and fiscal institutions, such regimes are generally not advisable. However, the cost of developing such institutions needs to be balanced against the cost of living with an underdeveloped financial system (if the banking system is forcefully pesified) or balance-sheet volatility (if the currency floats but most of the saving and lending continue to be done in foreign currency). It is not obvious that developing flexible labor market and fiscal institutions is more costly than developing the institutions necessary for a pesified financial system to become acceptable in a country like Argentina.

Finally, the authors argue that the demand for pesos following the break of convertibility was surprisingly strong. They mention that many analysts had indeed expected peso demand to collapse and the economy to become fully dollarized. The fact that this did not happen is seen as evidence that Argentines do, in fact, want to hold pesos, and it therefore provides hope for the pesification alternative. However, judging the demand for pesos in a context of stringent currency controls and a substantial increase in the share of the underground economy is, at best, heroic.

Graciela Kaminsky: Argentina's default and the demise of its currency board in January 2002 triggered a colossal interest in understanding what went wrong. This interest is not surprising. Until very recently, Argentina was the darling of Wall Street and the poster child...