Lessons from Argentina’s Dollarization Debate: The Challenge of the Commitment Device

With Javier Milei becoming president of Argentina, the debate over Argentina’s full de jure dollarization is gaining international attention. Mary Anastasia O’Grady offers a glimpse into the media’s diverse perspectives on this issue in the Wall Street Journal.

Many economists hold a negative view of dollarization and believe it would be a mistake for Argentina to relinquish the opportunity to conduct an efficient monetary policy. John Cochran dismisses this argument as a “laughable description of Argentina’s fiscal and monetary policies.” Argentina’s history reveals a consistent inability and unwillingness to implement efficient monetary policy, regardless of the political party in power or the fiscal situation. Even after experiencing fiscal and trade surpluses following the 2001 crisis, the country finds itself on the brink of hyperinflation after a decade of economic stagnation.

For those economists who resist the Nirvana fallacy of comparing real-world dollarization in Argentina to an imagined well-functioning central bank, a crucial issue emerges: the need for a credible commitment device. The Argentine Central Bank’s policies are not, and cannot be, considered credible regardless of how technically sound those policies may be.

It is essential to distinguish dollarization from other monetary regimes, such as a fixed peg or a currency board. Dollarization involves a single currency. Fixed peg and currency board regimes involve two distinct currencies tied together by monetary policy (fixed peg) or a commitment to exchange (currency board). This distinction has significant institutional implications. Unlike a fixed peg or a currency board, a government cannot easily abandon dollarization. 

Argentina has frequently abandoned fixed pegs. It has also voided peso convertibility to the US dollar. These options are unavailable under dollarization. De-dollarizing would require the government to introduce an entirely new currency that the public does not want. Consider the challenge of currency in circulation. Would the government go into individual houses and compel owners to exchange their US dollars for a new currency they reject? A dictatorship might pull off such a move. But in a democracy such a move would likely see incumbents ousted. 

The experience of Ecuador illustrates the point. Rafael Correa, who was president from 2007 – 2017, was an outspoken opponent of dollarization. But he never openly announced plans to de-dollarize Ecuador. His attempt to introduce the dinero electrónico was a total failure. As popular as Correa was, he couldn’t surpass the popularity of the US dollar. 

As a monetary regime, dollarization is an institution independent of local politics. That would make a big difference in Argentina, where the average terms of the Ministry of Economics and the Central Bank president are only 1.4 and 1.5 years, respectively. Argentina cannot offer a predictable fiscal and monetary policy with key officials turning over so frequently. Since dollarization is difficult and politically costly to reverse, it establishes credibility in countries where other options are not viable.

If Argentina were to dollarize, it would become the largest dollarized economy in the world. That experiment would directly challenge the assumption that dollarization is necessarily worse than having a central bank. If a large country like Argentina were to fare better under dollarization, economists would be forced to reconsider the role of central banks in monetary theory. But regardless of whether Argentina dollarizes, economists should be more conscious about the assumptions we take for granted. Many less-developed countries, like Argentina, lack the credibility and commitment devices that are commonplace in more-developed countries.

Related Articles – Central Banking, Inflation, International, Sound Money Project