Argentinas Monetary Crisis In the 1990s Argentina was the darling of the international financial community. The country had fixed the exchange rate for the Argentinean peso to the U.S. dollar at $1 = 1 peso. Maintaining the exchange rate required Argentina to adopt strict anti-inflationary policies, which had succeeded in bringing down Argentinas historically high inflation rate and stimulating economic growth. By 2001, however, the economy was running into trouble. Global economic growth slumped and demand for many of the commodities that Argentina exported had fallen in tandem. Argentinas large neighbor and main trading partner, Brazil, was grappling with a financial crisis of its own and had devalued its currency against the dollar, and thus the peso, effectively pricing many Argentinean goods out of its market. To compound matters, the dollar had appreciated against most major currencies, taking the peso up with it, and making Argentinean goods more expensive in other international markets. Starting in 1999, the Argentinean economy entered into a tailspin that was to take unemployment up to 25 percent by 2002. Anticipating that the country would have to devalue the peso against the dollar, corporations and individuals started to pull money out of pesos, placing their funds in dollar accounts. As people sold pesos, the Argentinean government used its foreign exchange reserves to buy them back in an effort to maintain the exchange rate at $1 = 1 peso. The government quickly ran down its reserves and in 2000, negotiated a loan from the International Monetary Fund (IMF) to prop up its currency. In return for the loan, which ultimately reached $15 billion, the Argentinean government agreed to adopt a financial austerity program to balance its budget. However, conditions in the country continued to deteriorate, in no small part, some critics claimed, because the strict IMF policies, by contracting government spending, made an already bad recession worse. Page 5 of 5 Solve the following questions & Case Studies: There would be a conceptual Answer which is based on an open book and you must not copy from a book, the internet or your friends and answer should be unique and authentic which you can only create on your own knowledge and research, otherwise the same answer would be reduced your marks from your allocated marks By late 2001, with government tax revenues plunging as the economy contracted, the Argentinean government defaulted on its debt repayments, effectively rendering $80 billion of government-issued bonds worthless. This created a massive crisis of confidence, which put further pressure on the peso. Throughout 2001 the Argentinean government had been trying to support the value of the peso with the help of a loan from the International Monetary Fund, but it was becoming ever more difficult, and the debt default was the final nail in the coffin. In early 2002, the government bowed to the inevitable and decoupled the peso from the dollar, allowing it to float freely. It immediately fell to $1=3.5 pesos. The fall in the value of the peso helped to revive Argentinean commodity exports, which were now much cheaper for foreign buyers. A rebound in global economic growth after 2001 also helped, as did an economic recovery in neighboring Brazil. By 2003, the economy was once more on a growth path and unemployment was falling. In 2005 Argentina repaid its entire debt to the IMF. Commenting on the debt repayment, Argentinean President Nestor Kirchner criticized the IMF for promoting policies that provoked poverty and pain on the Argentine people. While that view was popular in Argentina, some outside observers worried that freed from IMF constraints, the Argentinean economy would return to its historic norm of losing monetary policy and high inflation.

Case Discussion All Questions Must be Answered

a) How did the fixed exchange rate against the dollar that Argentina adopted in the 1990s benefit the economy?

b) Why was Argentina unable to maintain its fixed exchange rate regime? What does this tell you about the limitations of a fixed exchange rate regime?

c) Do you think that the IMF was correct to insist that the Argentinean government adopt a fiscal austerity program? What other approach could the IMF have taken?

d) In the end, the Argentinean government was forced to abandon its peg to the dollar. In retrospect was this a good thing? Why? What are the risks inherent in a floating exchange rate?