Argentina's collapse incited the largest default in history. Pundits agree this is merely the latest in a string of IMF-led bailouts that squandered billions of dollars and failed to save the economies they were meant to help. The nature of that failure, however, is disputed. Some claim that the IMF was too lenient; others that it was too tough.

Those who blame the IMF see the problem as self-inflicted through profligate and corrupt spending by Argentina. Such attempts at blame-shifting are misguided: one can understand the default as the consequence of economic mistakes made over a decade. Understanding what went wrong provides important lessons for the future.

The problems began with the hyperinflation of the 1980s. To slash inflation, expectations needed to be changed; ``anchoring'' the currency to the dollar was supposed to do this. This was a return to a variant of the old gold standard argument. If inflation continued, the country's real exchange rate would appreciate, the demand for its exports would fall, unemployment would increase, and that would dampen wage and price pressures. Market participants, knowing this, would realize that inflation would not be sustained. So long as the commitment to the exchange rate system remained credible, so was the commitment to halt inflation.

If inflationary expectations were changed, then disinflation could occur without the costly unemployment. This prescription worked for a time in a few countries, but was risky, as Argentina was to show.

The IMF encouraged this exchange rate system. Now they are less enthusiastic, though Argentina, not the IMF, is paying the price. The peg did lower inflation; but it did not promote sustained growth. Argentina should have been encouraged to fix a more flexible exchange rate system, or at least an exchange rate more reflective of the country's trading patterns.

Other mistakes in Argentina's ``reform'' program also occurred. Argentina was praised for allowing large foreign ownership of banks. For a while this created a seemingly more stable banking system, but that system failed to lend to small and medium sized firms. After the burst of growth that arrived with hyperinflation's end, growth slowed, partly because firms in the country couldn't get adequate finance. Argentina's government recognized the problem, but was hit by numerous shocks beyond its control before it could act.

East Asia's crisis of 1997 provided the first hit. Partly because of IMF mismanagement, this became a global financial crisis, raising interest rates for all emerging markets including Argentina. Argentina's exchange rate system survived, but at a heavy price - the onset of double-digit unemployment.

Soon, high interest rates strained the country's budget. Yet Argentina's debt to GDP ratio - even as it began to collapse - remained moderate, at around 45%, lower than Japan's. But with 20% interest rates, 9% of the country's GDP would be spent annually on financing its debt. The government pursued fiscal austerity, but not enough to make up for the vagaries of the market.

The global financial crisis that followed East Asia's crisis set off a series of big exchange rate adjustments. The dollar, to which Argentina's peso was tied, increased sharply in value. Meanwhile, Argentina's neighbor and Mercosur trading partner, Brazil, saw its currency depreciate - some say that it became significantly undervalued. Wages and prices fell, but not enough to allow Argentina to compete effectively, especially since many of the agricultural goods which constitute Argentina's natural comparative advantages face high hurdles in entering the markets of rich countries.

Hardly had the world recovered from the 1997-1998 financial crisis when it slid into the 2000/2001 global slowdown, worsening Argentina's situation. Here the IMF made its fatal mistake. It encouraged a contractionary fiscal policy, the same mistake it had made in East Asia, and with the same disastrous consequence.

Fiscal austerity was supposed to restore confidence. But the numbers in the IMF program were fiction; any economist would have predicted that contractionary policies incite slowdown, and that budget targets would not be met. Needless to say, the IMF program did not fulfill its commitments. Confidence is seldom restored as an economy goes into a deep recession and double-digit unemployment.

Perhaps a military dictator, like Chile's Pinochet, could suppress the social and political unrest that arises in such conditions. But in Argentina's democracy, this was impossible. In repeated visits to Argentina, I marveled at how long suffering the Argentineans were; to me, it is more a surprise that unrest took so long to manifest itself, not that street turmoil unseated Argentina's president.

Seven lessons must now be drawn:

1. In a world of volatile exchange rates, pegging a currency to one like the dollar is highly risky. Argentina should have been encouraged to move off its exchange rate system years ago.

2. Globalization exposes a country to enormous shocks. Countries must cope with those shocks - adjustments in exchange rates are part of the coping mechanism.

3. You ignore social and political contexts at your peril. Any government that follows policies which leave large fractions of the population unemployed or underemployed is failing in its primary mission.

4. A single-minded focus on inflation - without a concern for unemployment or growth - is risky.

5. Growth requires financial institutions that lend to domestic firms. Selling banks to foreign owners, without creating appropriate safeguards, may impede growth and stability.

6. One seldom restores economic strength - or confidence - with policies that force an economy into a deep recession. For insisting on contractionary policies, the IMF bears its great culpability.

1. 7. Better ways are needed to deal with situations akin to Argentina. I argued for this during East Asia's crisis; the IMF argued against me, preferring its big-bail-out strategy. Now the IMF belatedly recognizes that it should explore alternatives.

The IMF will work hard to shift blame - there will be allegations of corruption, and it will be said that Argentina did not pursue needed measures. Of course, the country needed to undertake other reforms - but following the IMF's advice regarding contractionary fiscal policies made matters worse. Argentina's crisis should remind us of the pressing need to reform the global financial system - and thorough reform of the IMF is where we must begin.