“Argentina’s Bold Currency Experiment and Its Demise”

Topics: Macroeconomics, Currency, Inflation Pages: 3 (1031 words) Published: April 27, 2011
Mini-Case “Argentina’s Bold Currency Experiment and Its Demise”

Argentina, once the world’s seventh-largest economy, has long been considered one of Latin America’s worst basket cases. Starting with Juan Peron, who was first elected president in 1946, and for decades after, profligate government spending financed by a compliant central bank that printed money to cover the chronic budget deficits had triggered a vicious cycle of inflation and devaluation. High taxes and excessive controls compounded Argentina’s woes and led to an overregulated, arthritic economy. However, in 1991, after the country had suffered nearly 50 years of economic mismanagement, President Carlos Menem and his fourth Minister of Economy, Domingo Cavallo, launched the Convertibility Act. (The first Minister of Economy, Miguel Roig, took one look at the economy and died of a heart attack six days into the job.) This act made the austral (the Argentine currency) fully convertible at a fixed rate of 10,000 australs to the dollar, and by law the monetary supply had to be 100% backed by gold and foreign currency reserves, mostly dollars. This link to gold and the dollar imposed a straitjacket on monetary policy. If, for example, the central bank had to sell dollars to support the currency, the money supply automatically shrank. Better still, the government could no longer print money to finance a budget deficit. In January 1992, the government knocked four zeros off the austral and renamed it the peso, worth exactly $1.

By effectively locking Argentina into the U.S. monetary system, the Convertibility Act had remarkable success in restoring confidence in the peso and providing an anchor for inflation expectations. Inflation fell from more than 2,300% in 1990 to 170% in 1991 and 4% in 1994 (see Exhibit 2.8). By 1997, the inflation rate was 0.4%, among the lowest in the world. Argentine capital transferred overseas to escape Argentina’s hyperinflation began to come home. It spurred rapid...
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