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Dear Mr. Milei: Don't dollarize, outsource the management of the Central Bank

2023-11-25T14:46:18.500Z

Highlights: Argentine president-elect Javier Milei inherits a desperate economic situation. With inflation running at more than 140% and interest rate at 133%, the last thing Argentina needs is "more of the same" Two well-known academics suggest hiring the Central Bank of Germany to carry out Argentina's monetary policy. The Bundesbank has what Argentina's central bank lacks: an honorable and long-standing record on inflation and the confidence of international markets, they say. They say Argentina's economy could regain flexibility and reach a level of credibility it never had before.


Two well-known academics suggest that the president-elect hire the Central Bank of Germany to carry out Argentina's monetary policy.


The unpredictable president-elect Javier Milei inherits a desperate economic situation. What will it do, really? With inflation running at more than 140% and Banco Ventral's interest rate at 133%, the last thing Argentina needs is the "more of the same" promised by its rival.

Dollarization is certainly different, but not a viable solution to Argentina's economic problems, which are real and deep. Luckily for Argentina, there is a better alternative available: outsourcing monetary policy to the Bundesbank (Germany's central bank), with complete political independence and clear yield targets.

To understand why, let's review recent economic history. Argentina is a middle-income country that fails to raise enough funds to finance its comparatively large welfare state. Since the 50s, the state has relied heavily on seigniorage for a significant portion of its finances.

Devaluations followed, within the framework of successive reforms that removed more and more zeros from the battered currency. One peso in 1992, for example, was worth 10 trillion pesos in 1970.

After generations of watching the value of their money evaporate, Argentines have rightly lost confidence in their leaders' ability to conduct monetary policy. Everyone, from lawyers to maids, bought dollars with their income on a weekly or even daily basis.

Hence the genius of the 1992 reform of the currency board (convertibility). Often analyzed as an economic policy, the truth is that it was a political strategy, a convincing and elaborate deception. By backing every peso in circulation for hard currency and squeezing itself into a legal straitjacket, the government convinced Argentines that their pesos were as good as dollars. Confidence and stability returned, and the economy flourished.

But a strategy inspired by the short term came with serious costs in the long term. The theory predicts that when the exchange rate cannot move to absorb external shocks, the adjustment occurs through real variables: prices fall, unemployment rises, output falls.

Javier Milei for now postponed his idea of closing the Central Bank. Photo: EFE/Juan Ignacio Roncoroni

This is what happened – very painfully – to Argentina, pushing it into recession after the Mexican crisis of 1994/1995 and, once again, after the Brazilian devaluation of 1999.

What was remarkable was that Brazil resumed its growth rapidly after devaluing, while Argentina, with its peso rigidly tied to the dollar, suffered years of recession, high unemployment, and a widespread social and political crisis.

Monetary policy flexibility is an essential component of any solution for Argentina. Dollarization is the opposite. It is a stricter version of the 1992 reform, which would drag Argentina down the same path as Ecuador, El Salvador, Panama and Zimbabwe, with no possibility of going back.

How do you achieve flexibility where people have no reason to believe in their monetary institutions and authorities? One concrete way would be to delegate monetary authority to some of the world's best and most trusted central bankers, who, by mere coincidence, were underemployed by the creation of the European Central Bank.

The Bundesbank has what Argentina's central bank lacks: an honorable and long-standing record on inflation and the confidence of international markets. If Argentina cedes the management of monetary policy to it, along with a clear British-style inflation target, the country's economy could regain flexibility and reach a level of credibility it never had before.

The impact of a future external crisis would be absorbed through careful monetary policy and a floating peso. The current destructive perception that any movement of the currency is tantamount to collapse would vanish. With the re-establishment of an independent monetary policy, the economy would have room to grow.

Opponents would no doubt clamor for sovereignty. "How did we cede monetary authority to foreigners?" But during convertibility, Argentina granted monetary authority to the U.S. FED, which did not even acknowledge receipt of it, and the nation celebrated. Our proposal would replace this with a program in which qualified technocrats are given an explicit mandate and can be held accountable for their performance. Far from giving up anything, Argentina would regain the possibility of an active policy.

Others will argue that the Bundesbank, or any other reliable central bank, would not accept the offer. Although more serious, this objection is not decisive.

The risk to their reputation would surely be offset by the prospect of being remembered as the authorities who, having achieved so much success for their own country, blazed a new trail for Argentina.

This is not a minor consideration given the currently limited role they have. And if the Bundesbank does not agree, other central bankers with enviable reputations are available. The euro, after all, replaced 20 currencies.

If history has brought Argentines to a painful situation, it also gives them a unique opportunity to exploit, for their own benefit, Europe's high-quality and underemployed human capital. By delegating monetary control, Argentina could, paradoxically, regain the benefits of an independent policy. This could lay the groundwork for substantial depreciation, modest inflation, and sustained growth.

Jean-Paul Faguet is Professor of Political Economy of Development at the London School of Economics and Tom Kirchmaier is Professor of Governance, Risk and Regulation at Copenhagen Business School.

Translated by: Ana Fernandez

Source: clarin

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