Argentina's Lessons

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.