Argentina’s Expansionary Monetary Policies

Subject: Finance
Pages: 6
Words: 1651
Reading time:
6 min
Study level: PhD

Introduction

Expansionary monetary policies have been extensively used by governments for combatting inflation and encouraging economic growth, although the case of Argentina in the 1990s shows that not all countries can benefit from them. To deal with the decline of the economy in the 1970-the 80s, the country adopted a fixed 1:1 dollar to peso rate, which presented a tremendous problem for the government under the threat of recession. However, while the case of Argentina showed that expansionary monetary policies do not always work, there is doubt about whether they do not work in the context of all developing countries. Therefore, this paper will examine the case of Argentina in the 1990s, discuss the barriers presented by currency devaluation, and determine whether expansionary monetary policies can succeed in developing countries.

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Case Overview

The debt crisis that occurred in Latin America in the 1980s caused a tremendous decline in Argentina’s economy, forcing the country to implement some radical measures to overcome hyperinflation and recession. The government decided to fix the Argentine peso to the dollar at the rate of 1:1 as well as restrict the issuing of new money. Throughout most of the 1990s, with the help of good work of the currency board, the country managed to maintain low inflation and steady growth, until the 1998 East Asia crisis reached Latin America. As a result of the crisis, Argentina had to deal with the decline in the economy due to the difficulties in exporting goods. To deal with it, the government should have made some changes such as cutting taxes or increasing the money supply, although the 1:1 exchange rate was a significant problem because Argentina was already experiencing a budget deficit that was very hard to control. With rising barriers, such as currency devaluation, Argentina found itself in a position of intense debates over what policies should be implemented to address the problem. On the one hand, the country could have adopted expansionary macroeconomic policies to deal with the recession at the cost of the peso devaluation. On the other hand, the government could have chosen to maintain the established 1:1 exchange rate at the cost of ignoring the recession. However, the recession began in 1999 and lasted for three years, resulting in the currency decline down to 0.27 pesos per dollar in June 2002. Therefore, some observers of the events that occurred in Argentina in the late 1990s argued that the government should have been more flexible in its policies by dealing with the 1:1 exchange rate before the recession had hit the country. Others also argued that the country could have made more severe budget cuts to maintain its currency, although the political obstacles prevented the government from making any significant changes.

To conclude the case overview, the events that occurred in Argentina still pose some questions to economists because as a rule, a recession that resulted from the demand’s decline is dealt with by increasing demand (tax or monetary policy, budget cuts, etc.). Although, if a country needs to show the global economy its fiscal prudence, the option of expansionary macroeconomic policies becomes a barrier rather than a facilitator.

Currency Devaluation

Currency devaluation was a major problem, whether it occurred intentionally or not. Currency devaluation is a deliberate “downward adjustment” in the value of a domestic currency of a country about another currency (Investopedia, n.d.). Countries that adopted a fixed or semi-fixed exchange rate usually use currency devaluation to make exports less expensive and capable of withstanding competition on the global market. However, this, in turn, causes the imports to rise in price, which influences the purchasing decisions of domestic consumers. During the years of the economy’s growth, companies and the government of Argentina were borrowing currency (dollars) in capital markets operating on an international scale. It is important to note that the borrowing of dollars was not unusual; however, there was a problem with the country raising revenue to service its debts being limited by the political factors existing on the domestic scale. While taking on debt in foreign currency is considered a normal procedure, it imposed a high price in an environment of currency devaluation because there were no changes in the dollar value of debt, although the value of the domestic currency increased. Because most companies and the government were acquiring profit in Argentine pesos while their international debts were in dollars, any processes that negatively influenced the value of the domestic currency would impact the burden of their debt.

Because Argentina was hit by the fall in the economy in the 1970s and 1980s, the majority of its actions in the 1990s were targeted at raising the level of trade and increasing the demand for the peso, which could ultimately contribute to the peso’s appreciation (Osho & Uwakonye, 2009). Although, the country went even further with establishing a fixed 1:1 exchange rate. While the government had a plan of policy implementation, strong economic growth was needed to prevent recessions. Therefore, Argentina needed to generate earnings on its foreign exchange (Osho & Uwakonye, 2009) to pay out the international debt, which required the country’s exports to exceed the imports (Feldstein, 2002). However, the 1:1 ratio of peso to the dollar only limited the country’s export abilities since it made the domestic products too expensive to compete with the alternatives offered by foreign countries. Moreover, to pay out the international debt, production had to rise at a faster pace compared to wages; this could have helped with the decline of prices on Argentinian goods (Moreno, 2002). Although, none of the mentioned processes were to happen because the pressure from unions alongside labor laws prevented the reduction in production costs that the country needed for staying competitive on the global market. Therefore, currency devaluation was the only option for reducing the impact of recession since the convertibility law allowed for shifting pesos into dollars and taking them out of the country (Feldstein, 2002).

The question of “Why Argentina did not devaluate the domestic currency sooner?” can be answered simply: the government showed resistance. First, there was a fear that the break of the 1:1 peg and peso devaluation would increase inflation (Osho & Uwakonye, 2009). Second, the devaluation of the peso could potentially create chaos due to the large amounts of dollar-denominated debt, because devaluation will essentially mean the rise in the peso value of outstanding debts (Osho & Uwakonye, 2009). This, in turn, could influence central and provincial governments within the country; because tax revenue of the governmental bodies was collected in pesos, local governments were struggling with paying out their debts in dollars. Third, the government hoped that with time the situation would improve because of the expectations of the dollar’s decline relative to the European currencies, which did not happen. Therefore, a problem question arises: does this mean that expansionary macroeconomic policies cannot be used by developing countries?

Developing Countries and Expansionary Macroeconomic Policies

While the adoption of expansionary macroeconomic policies (various tools used by the government to stimulate the economy) did not work for Argentina, it cannot be asserted that these policies do not work for all developing countries. Expansionary macroeconomic policies can increase aggregate demand, lower interest rates, or increase the money supply (Amadeo, 2016); however, the success of the policies depends on the economic conditions at the time of the crisis experienced by a country (Nicaretta, Izquierdo, & Cavallo, 2009). Therefore, if the government of a developing country did not save monetary resources during the years of booming growth, there will be limited scope for increasing the spending for dealing with the recession.

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According to the study conducted by Nicaretta et al. (2009), countries with enough resources that we’re able to implement monetary policies had a loss in the input of under 5% in the crisis’ aftermath while those with much less flexibility reported a loss in the input of 10% and above. Countries that adopt expansionary macroeconomic policies can do better; however, it does not mean that countries that don’t adopt them could have had better outcomes had they done the opposite (Nicaretta et al., 2009). In some cases, like in the case of Argentina, the economic conditions were weak at the beginning (the 1970-80s fall in the economy), so any attempts to be more aggressive in dealing with the crisis only exasperated the problem.

Conclusion

The case of Argentina’s implementation of expansionary macroeconomic policies remains a debated topic since there was a chance for the government to deal with the crisis in the earliest stages. However, the devaluation of the Argentine peso against the U.S. dollar presented a significant challenge due to tremendous dollar-denominated debt from foreign investors. The devaluation of the domestic currency was associated with the increase of debt in pesos, and the government could not go that far, even though it could have been the most appropriate solution to the problem.

Expansionary macroeconomic policies have the potential for alleviating the burden of crisis with which a country is dealing. However, there should be solid economic support from monetary resources that a developing country saved during the years of growth; otherwise, expansionary macroeconomic policies can bring more problems than solutions.

References

Amadeo, K. (2016). Expansionary monetary policy: Definition, purpose, tools. Web.

Feldstein, M. (2002). Argentina’s fall. Business Source Premier, 81(2), 8-14.

Investopedia. (n.d.). What is devaluation. Web.

Moreno, R. (2002). FRBSF economic letter: Learning from Argentina’s crisis. Web.

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Nicaretta, R., Izquierdo, A., & Cavallo, E. (2009). Expansionary policies to fight the crisis work, but not for all countries. Web.

Osho, G., & Uwakonye, M. (2009). Economic potentiality and consequences of inflation in Argentina. Journal of Business Case Studies, 5(1), 19-28.