currency board and crisis in Argentina
The crisis in Argentina has raised major concerns about the functioning of exchange rate system for an emerging economy. Much of the blame, for Argentina’s current woes, has been put on the country’s Currency Board System (CBS), which was introduced in 1991. ... Was Argentina a suitable candidate for adoption of Currency Board System? To what extent can the current recession be blamed on the currency board policy? A currency board is a permanently fixed exchange rate backed by the absolute promise of the government of the establishing country to issue or redeem the local currency at a fixed rate against a foreign “anchor” currency. ... In other words, the money supply adjusts to the level dictated by the official gold and foreign currency reserves. A successful adoption of currency board system depends on a firm and wide belief that the long-term economic benefits of exchange rate stability are worth the loss of monetary sovereignty and the abandonment of some policy choices. Because CBS provide a nominal anchor that breaks rapidly the domestic inflationary dynamics by tying the prices of domestically produced tradable goods to those in the anchor country, they are usually used to restore monetary stability after episodes of currency crises and failed stabilization programs. Argentina adopted a Currency board in April 1991. ... At that time, the Currency board appeared like a solution of last resort to put an end to hyperinflation in a country that experienced no less than eight major currency crises since the beginning of the 1970s. ... In addition, the banking crisis of 1980 and the subsequent bailout of financial institutions by the central bank brought about a substantial increase of domestic credit in US dollars in the economy. ... The national currency was gradually being replaced by the US dollar both as bank holdings and as means of payments. To arrest hyperinflation and restore the faith of the general public in the country’s currency, a Currency Board Arrangement (CBA) was introduced in April 1991, By announcing that each unit of domestic currency would be backed by a US Dollar, the country effectively promised not to use the printing press to bridge future budget deficits. ... Argentina had a four-digit inflation in 1989 and 1990, but the Consumer Price Index (CPI) fell sharply to the low three-digit during the first year of Argentina’s monetary move and to two-digit one year later. ... In all, the sustained level of high growth of production between 1991 and 1994 and the dramatic fall in inflation show that Argentina reaped the full benefits of the currency board in the early years of its implementation. But Was Argentina a suitable candidate for adoption of Currency Board System? ... Firstly, a credible anchor currency can be identified. In practice, the business cycle of the country to which it wishes to peg its currency must closely correlate with its own and the share of that country in its external trade must be significant.