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in 1990 as the developing world’s most promising success story. In a nation that has historically
been troubled by inflation, bank failure, and military coups, the early 1990s were exceptional
times for Argentina. Output grew robustly at a 6.1%1 annualized rate, inflation remained
contained, and foreign direct investment increased as the prospects for Argentina’s growth
brightened. Under the presidency of Carlos Saul Menem and the Economics Minister Domingo
Felipe Cavallo, several liberal economic policies were pursued, including a reduction of import
tariffs, the privatization of several state-run corporations, and an expansion of the tax base.
Argentina’s persistent inflation bias disappeared as the government abolished the central bank in
favor of a currency board, which eliminated the nation’s ability to print money and tied the peso
to the U.S. dollar. Argentina also emerged unscathed from both the Mexican and Asian crises
which rattled emerging markets across the globe. This period of reforms and dramatic success,
however, proved to be fleeting. In 2000, the Argentine economy sunk into a period of deep
recession, fiscal delinquency, mounting foreign debt, and social strife. Not only was the
government unable to rein in spending, but it was increasingly reliant upon financing the fiscal
deficit by issuing bonds at a spread of over forty percentage points higher than American
treasuries. The market proved correct in demanding such a hefty risk premium on Argentine
1
“A Decline Without Parallel.” The Economist, 28 February 2002.
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economic contraction brought the country to crisis. Ultimately, the Argentine crisis resulted in
the largest sovereign debt default, a radical abandonment of the currency board, and utter misery
for the Argentine people. This paper will examine both internal and external factors that
Economic reforms in the early 1990s were hugely successful, but several problems still
lurked in the Argentine economy. In an effort to prevent the chronic hyperinflation that had
plagued the country in the past, Argentine policymakers took a hard-line stance on inflation and
adopted the Convertibility Plan, which included several liberal economic reforms and established
a currency board. The Convertibility Law stipulated that each peso in circulation be backed by
exactly one U.S. dollar held by the central bank, preventing the government from financing the
fiscal deficit with newly printed pesos. This solution to resolving the central bank’s inflationary
tendency proved successful in containing prices, but deleterious to the economy’s flexibility and
the central bank’s ability to manage output shocks. The peg prevented the central bank from
the peg prevented the central bank from printing additional pesos to avert bank failure when
depositors demanded the withdrawal of $15 billion from commercial banks. Not only did the
fixed exchange rate render monetary policy impotent in correcting short-run economic
fluctuations, but it manipulated the real exchange rate to an inappropriate level given Argentina’s
economic fragility.
During Argentina’s boom years, the government ran only modest budget deficits, and
even ran the occasional surplus. Government revenues, however, soon proved to be inadequate
to cover interest payments on outstanding debt. Public debt grew exponentially as public sector
expenditure increased and the government assumed payments for the transitioning social security
system. When the economy sank into a deep recession in 1999, fiscal authorities responded to
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the mounting government debt by raising taxes and cutting government spending, an egregious
policy mistake during a recession. In hopes of cutting expenditure, the government attempted to
release labor from many of the state-owned enterprises, but this policy proved to be futile, as
unemployment led to massive social unrest. Adding to the country’s fiscal woes was that the
government lacked the infrastructure to collect a greater portion of GDP in tax revenues.2
Furthermore, Argentine fiscal problems were exacerbated by the structural relationship between
the central and provincial governments. The central government was responsible for collecting
tax revenues which were then distributed and spent by the provincial governments. This system
of fiscal management banished any incentive for provincial governments to rein in spending and
deficits resulted at both levels of government. The inefficiency of the Argentine tax system is
reflected by the government’s meager tax collections, amounting to only 21% of GDP compared
to Brazil’s 30% and many developed countries’ levels approaching 50%.3 The result of
Argentina’s fiscal problems was increasing debt, which in 2001 reached nearly 55% of GDP, a
dangerously high for a developing country with questionable revenue systems. Being a
developing country with mounting debt, rising interest rates, and persistent budget deficits made
Furthermore, contributing to the fiscal deficit and lack of export competitiveness were
rigidities in the Argentine labor market. During the late 1990s, public sector employment
accounted for 12.5% of the labor force.4 Both the existence of these jobs and the level of wages
were guaranteed by strong organized labor unions and political cronyism. As the economy fell
into recession, unemployment rose as labor was released from the private sector, but federal jobs
2
“A Decline Without Parallel.” The Economist, 28 February 2002.
3
Tella, Rafael Di, “The 2001 Crisis in Argentina: An IMF-Sponsored Default?” Harvard Business School, 7 January
2004.
4
Krueger, Anne, “Crisis Prevention and Resolution: Lessons from Argentina.” International Monetary Fund, 17
July 2002.
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were maintained with wages nearly 45% higher than the private sector. 5 Not only did the federal
payroll prove to be a burden on the economy, but wage rigidity prevented prices from falling,
maintaining the real exchange rate at high levels and reducing export competitiveness.
Adding to fiscal weakness, rigid prices, and a lack of monetary policy flexibility was a
weak banking system. In contrast to most economic crises, in which banking system weakness
precipitates economic crisis, Argentina’s experience was the opposite. The economic crisis and
the government’s fiscal stance brought about a weakness in the banking system which
exacerbated the contraction in output and created social unrest. As the government deficit
expanded and debt swelled, the central bank raided banking deposits by strong-arming pension
funds and local banks to buy risky government bonds at below market interest rates.6 If the
banking system were more independent, commercial banks would never have foolishly bought
government bonds and surrendered deposits. News of the government’s raid on banking deposits
prompted a bank run and the government responded with a freeze on withdrawals, violating
basic principles of private property and trust between citizens and government. The deposit
freeze and seizure of bank deposits disrupted the link between savings and investment, led to
rioting in the streets, and dispelled any remaining faith Argentines had in their government.
While many internal policy decisions made Argentina susceptible to economic crisis and
default, international events ultimately led to the catastrophe. For years, the currency board was
hugely successful in containing inflation, but the dollar peg imposed a great cost on the
economy. With the value of the peso pegged to exactly one dollar, exports suffered as the trade-
weighted value of the dollar rose over 30% from 1998 to 2002.7 Additionally, beginning in 1999,
the U.S. Federal Reserve began raising interest rates to cool the U.S. economy just as Argentina
plunged into recession. Because the Argentine central bank was effectively abolished by the
5
Krueger, Anne.
6
“A Decline Without Parallel.” The Economist, 28 February 2002.
7
Board of Governors of the Federal Reserve System, Trade Weighted Exchange Index: Broad.
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Convertibility Plan, monetary policy was set by the American Fed through the peso peg. The
combination of rising interest rates and a nominal appreciation of the dollar muted Argentine
output growth and burdened exporters. Adding to the decline in competitiveness, was the
Brazilian devaluation of the real in 1999, which made Argentine goods more expensive relative
to Brazilian goods. Further contributing to a high real exchange rate were rigid wages supported
by strong organized labor interests. As the economy fell into recession prices remained high,
preventing the real exchange rate from falling and the country’s exports from becoming more
competitive.
Additionally, the International Monetary Fund is frequently blamed for the crisis in
Argentina, as illustrated in Nestor Kirchner’s comments to IMF managing director Horst Kohler,
“You are greatly responsible for what happened in Argentina.”8 In order to receive aid from the
IMF, Argentina was under pressure to meet fiscal goals to comply with austerity. To reduce the
government deficit, policy makers were forced to cut spending and increase taxes as economic
growth stagnated, exacerbating the recession. Additionally, IMF intervention introduced the idea
of moral hazard. If the Fund stood to remedy the situation, Argentine policymakers had little
incentive to manage the fiscal deficit. Swelling debt, fiscal imbalance, and ultimately the IMF’s
During Argentina’s boom years and as the economic crisis developed, policymakers
could have taken several steps to restore the health of the economy and safeguard it for the
future. Instead, Argentine policymakers chose to ignore several problems in the economy. In
retrospect, viable policy recommendations include inflation targeting, fiscal planning, increasing
8
Tella, Rafael Di, “The 2001 Crisis in Argentina: An IMF-Sponsored Default?” Harvard Business School, 7 January
2004.
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While the currency board solved the problem of inflation, it came at an enormous cost.
Rather than addressing the inflation problem with an exchange rate peg, the central bank should
have established an inflation target, which would offer at least some policy flexibility in the
event of an economic crisis or shock to output. By targeting a rate of inflation, the peso would
be allowed to float on world markets and the central bank would be free to stabilize output. The
currency board simply tied Argentina’s economic fate too closely with external variables.
Additionally, prudent fiscal planning and higher tax revenues would have averted the
crisis. During the boom of the early 1990s, the government failed to cut spending and raise
taxes. Having a budget surplus could have reduced the risk premium demanded on Argentine
bonds and allowed the government to implement expansionary fiscal policy during the crisis.
With a fixed exchange rate, fiscal policy is the only tool available to policymakers, and when
creditors are no longer willing to lend, expansionary fiscal policy during a budget deficit
becomes unavailable as well. With respect to taxation, compared to its neighbors, Argentina
collected far less of its GDP in taxes. Improving basic accounting systems and discouraging the
underground economy would have increased government revenues. Finally, making provinces
fiscally accountable would have decreased budget deficits as individual regions were made
accountable for their own collection and spending, aligning incentives and reducing reckless
spending.
Furthermore, increasing labor market flexibility would have helped Argentina weather the
economic crisis. As the recession set in, government employees earned nearly 45% more in
wages that private sector employees and comprised 12.5% of the labor market.9 With strong
labor unions and the government’s reluctance to trim its payroll, prices in the economy were
reluctant to fall. Flexible prices would have enabled labor markets to clear and the economy to
9
Krueger, Anne.
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adjust to output shocks. A falling price level would have also encouraged exports as
competitiveness increased.
Argentina’s debt rose to astronomical levels in the 2000-2001 period, there was little hope of
repaying the principal plus interest, as debt levels were several times the government’s annual
tax revenues. Limiting government borrowing to what the government is able generate in
revenue during a given year would have avoided the debt crisis, default, and the government’s
inflationary tendencies, profligate spending, high tax evasion, and organized labor at the federal
level. If Argentina were to have enacted these measures gradually throughout the 1990s, when
output grew robustly, the debt crisis likely would have been averted and the external shocks to
output could have been reduced. Policymakers should have attempted to remedy Argentina’s
economic condition during the period of high output growth. The apparent Argentine miracle of
the early 1990s proved too good to be true as unfettered optimism led to irresponsibility and a
reversal of fortune.
Works Cited
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Board of Governors of the Federal Reserve System, Trade Weighted Exchange Index: Broad
Krueger, Anne. “Crisis Prevention and Resolution: Lessons from Argentina.” International
Tella, Rafael Di. “The 2001 Crisis in Argentina: An IMF-Sponsored Default?” Harvard Business
Graphs
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