Webpages useful for teachers of intermediate macroeconomics:

Argentina's Crisis


Powerpoint Version

Q: Why is Argentina in a recession?

A: Because everyone expects the value of the peso to decline, everyone is charging Argentinian borrowers high real interest rates to compensate for the likely future decline in the value of the peso. Higher real interest rates mean low investment, and low investment generates recession and high unemployment.

Q: Why does everyone expect the value of the peso to decline?

A: The peso is overvalued--that is, the current value of the Argentinian exchange rate is less than foreign exchange speculators' consensus estimate of its long-run likely value--for three reasons: (i) the U.S. dollar has risen sharply in value over the past four years, and the value of the peso has been tied to the value of the dollar; (ii) Argentinian state and federal governments have been running large deficits that have led to expectations of inflation and devaluation; and (iii) at the current exchange rate costs in Argentina are well above costs in its trading partners.

Q: Why doesn't Argentina simply devalue--reduce the value of the peso vis-a-vis the dollar? Then Argentinian interest rates would fall (because lenders would no longer need to be compensated for future devaluation because the devaluation would have already taken place), and as a result Argentinian investment would boom. Moreover, a lower value of the peso would make Argentinian producers more competitive on international markets, and exports would boom. Devaluation would quickly pull Argentina out of its recession.

A: There are two reasons that Argentina has not already devalued the peso. First, it promised not to--fixing the value of the peso to the dollar by setting up the currency board and promising to keep the peso fixed against the dollar was the way that then-Argentinian finance minister Domingo Cavallo solved Argentina's inflation problem at the start of the 1990s. Second, most Argentinian debtors' obligations are denominated in dollars: devaluing the peso to, say, half its current value would thus double the peso value of their debts and send them into bankruptcy. High interest rates are bad and discourage investment. Near-universal bankruptcy is even worse and discourages investment even more. Were it not for the dollar-denominated debts in Argentina, devaluation might well cure the recession--that was what Britain did successfully in 1992, after all, when it abandoned its commitment to the western European Exchange Rate Mechanism.

But Argentina does have massive dollar-denominated debts, and so has no good options available.

Previous Handouts

2001-12-10: The U.S. Recession (Chapter 2: Principal Macroeconomic Variables)
2001-12-03: The Overvalued Euro (Chapter 3: Exchange Rates; Chapter 15: Exchange Rate Regimes)
2001-11-26: Net Exports, the Exchange Rate, and an IS-Led Boom (Chapter 11: Balance of Payments; Chapter 15: Exchange Rate Regimes)
2001-11-19: The European Central Bank and Its Monetary Policy (Chapter 13: Stabilization Policy)
2001-11-12: Central Banks Worldwide Cut Interest Rates Again (Chapter 13: Stabilization Policy)
2001-11-05: Effects of the Collapse in Spending on Durables (Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-28: What Kind of Stimulus (Chapter 13: Stabilization Policy. Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-21: Federal Reserve Reaction to the Terror Attack on the World Trade Center (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)
2001-10-14: Why a Stimulus Package Might Be Desireable (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)

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