Dollarization in Argentina
Velde, Francois R., Veracierto, Marcelo, Economic Perspectives
Introduction and summary
In January 1999, Argentina announced that it was considering adopting the U.S. dollar as its sole medium of exchange. This policy proposal, which is known as "dollarization," received considerable attention from both policymakers and the media, generating an ongoing debate. This article discusses from a critical perspective some of the issues raised in this debate. Although we do not reach a definite answer on whether Argentina should dollarize, we believe that our work sheds considerable light on the costs and benefits associated with it.
The debate over dollarization is part of a broader, longstanding, and ongoing debate over the relative merits of monetary arrangements. The general question is whether a country's currency should be tied to some anchor, and, if so, to which anchor and how tied. The question involves a variety of issues, depending on the context in which it is raised. In the international context, this question becomes the debate about fixed and flexible exchange rates and optimal currency areas.  Dollarization is simply the most extreme form of a fixed exchange rate. When one abstracts from international considerations, as one would for a relatively closed economy like Argentina's, in which international trade matters less, the context is the debate over "rules versus discretion": Should monetary policy be tied to a rigid rule or should central bankers be allowed discretion in their conduct of policy? Dollarization is the ultimate rule, or the total absence of discretion.
While the choice of anchor for monetary systems has been debated for centuries, the question of dollarization has been posed relatively recently. Indeed, Mundell wrote in his classic paper (Mundell, 1961) that "it hardly appears within the realm of political feasibility that national currencies would ever be abandoned in favor of any other arrangement." More recently, Schwartz (1993) wrote in her review of the history of currency boards that "central banks seem to me strongly entrenched and unlikely to be dislodged even if their policies create hyperinflations." Yet currency boards have made a comeback of sorts, with Hong Kong since 1983 and Argentina since 1991 as the most prominent examples.  Dollarization has been evoked in Argentina. But the debate has sprung up elsewhere. Just as the European common market led to European monetary union, some have argued that the members of the North American Free Trade Agreement, particularly Mexico, should seriously consider dollarization. Most recently, on January 9, 2000, the president of Ecuador announced plans to immediately dollarize his country's economy, retaining the local currency only for small change.
American officials have repeatedly taken a very balanced position on the matter; while not rejecting the idea out of hand, and while admitting that the U.S. could not prevent a country from adopting the dollar as currency, they have issued strong cautionary notes. At present, following the election of a new president on October 25, Argentina has stated a strong commitment to the current currency board arrangement, and U.S. Secretary of the Treasury Lawrence H. Summers recently concluded that the question of dollarization is not on Argentina's agenda. The topic, however, has now raised interest in academic and business circles.
This article restricts attention to the particular case of Argentina. Argentina has a long history of disastrous monetary policies and repeated hyperinflations, which have led it to peg its currency to the dollar since 1991. Since Argentina is in practice already quite close to being fully dollarized, it presents a good illustration of what is (and is not) required for a successful dollarization and what are the costs and benefits associated with it.
We first present the facts about Argentina's case, in particular the historical background to Argentina's peg to the dollar since 1991. …