Role of Exchange Rate Regime in Argentinas 2001 Crisis

Role of Exchange Rate Regime in genus Argentinas 2001 CrisisDiscuss the role of the commute treasure regime in modify to the 2001 crisis in Argentina.IntroductionFor much of Argentinas history, the rural area has been plagued by a cycle of sparing and governmental instability. Despite the provinces rich resource point of view, the providence performed badly from the 1950s to the early 1990s. harmonise to the Economist (2002), among 1976 and 1989, income per person shrank by more than than 1% per year. devil bouts of hyper pomposity, and two banking collapses, destroyed confidence in both the peso and economic form _or_ system of government. In dedicate to combat this, in 1991, Menem and his economy minister Domingo Cavallo finalizeged the Argentinian peso one-to-one with the vaulting horse, and this succeeded in halting inflation. However, within ten age this came to be seen as a mistake. Aside from being a subject matter to control inflation, the transmute rate regime can also be seen as Menem deliberately tying his hands in order to cancel taking responsibility for sensitive or unpopular decisions. For example, prices could now originate without wage increases due to bills devaluation.Menem had been a very popular death chair alone in the end he left his second destination of office in 1999 very much discredited. His government oversaw the development of abrupt inequalities and the increasing resentment of the discluded. He lacked any brassatic pro-poor or pro-development policies. Menem minify inflation from a high of about 5000% to 0 and until about 1999, the economy was doing well with stable inflation and stable nurtureth (an average annual rate of 6.1% in the midst of 1991 and 1997). From 1999, however, there was serious recession in Argentina and by 2001 just about every(prenominal)thing that could be wrongly with an economy (aside from inflation) was wrong with the Argentinian economy, and in early 2002 the country def aulted on its $155 meg public debt. The Economist (2002) spoke of the awe-inspiring severity of the economic, financial, political and social collapse of Argentina.This essay first examines the theoretical arguments in favour of adopting a pegged deepen rate. Turning to the case of Argentina, the essay then investigates why the re-sentencing rate regime implemented by Menem did not work, how this contributed to the 2001 crisis, and what other factors contributed to the crisis.Pegged commute ratesA government has variant different options in monetary value of interchange rate mechanisms (Fischer 2001). The cash can be allowed to float freely, the exchange rate can be pegged to another currentness or collection of currencies in a soft way such that the relevant government agree to defend the peg but can re-value it if the exchange rate comes under heavy pressure, or it can be pegged firm. Alternatively, some countries subscribe to chosen to do away with their national notes altogether and enforce only the dollar this is known as full dollarization. Argentina opted for the hard peg a currency mount in 1991. A currency board maintains a touch on exchange rate with a inappropriate currency thus subordinating conventional monetary policy objectives to the exchange rate target (a peg with the US dollar, for example, maintains interest rates and inflation very close to those in the United State). For an orthodox currency board, the countrys foreign currency reserves must be satisfactory that all holders of the domestic currency could convert it into the reserve currency.The key proceeds of a currency board is that currency stability is no seven-day an issue because the exchange rate is fixed to a hard currency and the level of inflation is de statusined in the country of that hard currency. On the other hand, a country which adopts a currency board gives up the ability to manipulate monetary policy according to domestic considerations. Furthe rmore, the fixed exchange rate will determine the countrys terms of trade.The exchange rate regime in ArgentinaThe dollar peg made exports expensive and imports cheap. This resulted in dollars flowing out of the country, and this combined with a heavy debt burden reduce the reserves of dollars. The government ended up with only a fraction of the reserves necessary to maintain the currency board successfully and this was one of the major reasons for the crisis of 2001. While there were distinctly other contributing factors, de la Torre et al (2002) argue that the relationship between the exchange rate regime and the Argentine banking system is key to reasonableness the crisis, and that an early move from the pegged board to full dollarization could get hold of reduced the magnitude of the economic collapse. The establishment of the currency board in 1991 helped develop the Argentine financial system. Despite its strengths, the financial system remained vulnerable to real exchang e rate misalignments and fiscal shocks. After 1998, Argentina fell into a currencygrowth-debt trap. It attempt to break away by focusing on growth, but failed to target the currency and debt components of the trap, dramatically raising uncertainty. This unleashed a depositor run, which lead to the abandonment of the currency board (de la Torre 2002abstract). Being tied to the highly valued dollar also hurt the economy as Argentine exports became relatively more expensive. As demand for exports fell, Argentina had to turn to the IMF for emergency loans worth $21.6 billion.What other factors contributed to the crisis?It is important to remember that this was not the first crisis that Argentina has suffered. In order to fully understand the causes of the 2001 crisis, it is necessary to put it into historical perspective. Arguably every president since Peron came to power in 1946 had aggravated the countrys economic, political and social problems with an over-personalised style of lea dership characterised by corruption and the use of endure (financed by publish money) to maintain favour. The historical mismanagement of the economy whitethorn beat sowed the seeds for the 2001 crisis. In addition various external factors can be seen as trigger causes, contributing to the specific timing of the economic collapse.In the first place, the prices for Argentinas exports stopped rising. Although the total value of exports did grow from 1999 to 2001, the rate of growth was hampered by protectionism and subsidies in rich countries, and many industries could no longer compete abroad. Argentinas largest export partner was brazil, a country which was facing economic difficulties of its own. The negative effect on the Argentine economy was two-fold Brazilian economic problems and a devaluation not only reduced demand for Argentine exports, but lower wages in Brazil attracted many Argentine manufacturers to move their factories across the border into Brazil.Ollier (2003184) points to the fragmentation of the politico-institutional system and the extreme dependency of the economy on foreign credit as the major causes of the collapse. The loose fiscal policy of Menems second term certainly did nothing to help the economy. While his predecessors had encouraged hyperinflation by printing money to buy political support, Menem now printed bonds to finance the fiscal deficit, and the countrys public debt rose and rose.ConclusionArgentina is not a country which should have any problems it has a rich resource base and a relatively homogeneous population. Yet Argentina has long suffered various economic problems (as well as political and social problems). High levels of mind-set have consistently not been matched by performance. Severe sectoral conflict between the agricultural and industrial sectors has hampered economic development. The existence of three highly organize social groups, each attempting to shape economic policy has also clutches the ability of the government to manage the economy effectively landowners may have few votes but they have immense economic power the Argentine union movement is one of the most powerful in the being and the business sector is highly organised and incorporated into the state apparatus. In addition the political systems and institutions have fostered high levels of corruption with devastating effect on the economy. The federal government is unable to curb the fiscal pulmonary tuberculosis of the provincial governments. Neo-liberalism requires effective, independent regulatory mechanisms but in Argentina the effectual system is too weak and is incapable of scrutinising audit commissions etc. Furthermore, the presidentship is too strong and there are no institutional safeguards to keep the presidency in check. The liberal policies of the 1980s and 1990s stabilised the economy, but at the cost of rising unemployment which, coupled with cuts in welfare provisions, took mendicancy to new dept hs. Various external shocks brought about the crisis in 2001 but had the exchange rate regime not been in place, the economy may have been sufficiently flexible to respond to, and recover from, these shocks. The rigidity of the currency board and the corresponding inability of the government to manipulate exchange rate policy or monetary policy is what permitted these shocks to lead to such a painful economic collapse.Bibliographyde la Torre, A., Levy Yeyati, E. Schmukler, S. (2002) Argentinas Financial Crisis adrift(p) Money, Sinking Banking (downloaded from http//www.econ.umn.edu/tkehoe/classes/Schmukler.pdf on 19 March 2007)Economist (2002) Argentinas collapse A decline without parallel, The Economist, 28 February 2002 (downloaded from www.economist.com on 19 March 2007)Fischer, S. (2001) Distinguished Lecture on economicals in regime Exchange Rate Regimes Is the Bipolar View Correct?, The Journal of Economic Perspectives, 15(2) Spring, 2001, pp. 3-24.Ollier, M. (2003) Argen tina Up a Blind Alley Once once again, Bulletin of Latin American Research, 22(2), pp 170-186