Working Paper: CEPR ID: DP3399
Authors: Javier Fronti; Marcus Miller; Lei Zhang
Abstract: To check hyperinflation, Argentina pegged the peso at one US dollar in 1991. This stopped inflation in its tracks: but, with the rise of the dollar against the Euro and the substantial devaluation of the Brazilian real, the peso became increasingly over-valued leading to a significant country-risk premium on Argentine dollar liabilities as devaluation with ?pesification? was anticipated. Here, we apply the Ozkan and Sutherland (1998) model of over-valuation and currency crisis to analyse three scenarios: (i) that Cavallo unnecessarily delayed devaluation, (ii) that the delay was reasonable, and (iii) Cavallo?s view, that the peg should have been preserved but was destroyed by self-fulfilling panic. In conclusion, we argue that, as the costs associated with devaluation and default are largely determined ex post, so the appropriate interpretation depends on how the crisis is handled.
Keywords: currency crisis; multiple equilibria; regime switches
JEL Codes: D84; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market expectations of devaluation and default (F31) | rising interest rates (E43) |
| rising interest rates (E43) | economic downturn (F44) |
| abandonment of the pegged exchange rate (F31) | less severe economic costs (F69) |
| anticipation of devaluation (F31) | observed economic downturn (F44) |
| decision to maintain peg despite deteriorating fundamentals (F31) | increasing economic damage (F69) |
| devaluation (F31) | interest rates (E43) |
| devaluation (F31) | economic activity (E20) |