Diapositiva 1

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Monetary Policy in Dollarized Economies The
Argentine Experience
MIGUEL A. KIGUEL
Universidad Di Tella econviews
December 2006
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Monetary Policy in dollarized economies Outline

• General reflections about dollarization
• How does dollarization affect the banking system
• The experience of Argentina as a dollarized
  economy during the hard peg and after the 2001/02
  Crisis
• Final remarks and issues for discussion

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Monetary Policy in dollarized economies under
different exchange rate regimes

• Fixed exchange rates (currency board)
  Little room for monetary policy but the central
  bank can affect the amount of bank credit.
• Floating exchange rates room for monetary
  policy, the main question is how effective can it
  be when dollarization is significant.
• Is it better to target the money supply or
  interest rates in highly dollarized economies?
• Is there a difference between dollarization and
  currency substitution?

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International Comparison
econviews
Argentina is one of the few countries that
managed to de-dollarized
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How can dollarization help banking stability?

• Dollarization allows portfolio changes to take
  place within the banking system, and hence it
  helps financial deepening
• Reduces capital flight
• Interest rates on dollar deposits and loans are
  largely insulated from changes in peso interest
  rates
• It helps to develop a market for long term
  financial instruments (e.g. mortgages)

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How can dollarization weaken banking stability?

• Lack of confidence on the currency could lead to
  a systemic run of deposits
• Lack of lender of last resort could lead to bank
  panics
• Regulations do not usually include prudential
  regulations to limit convertibility in a panic
  (circuit breakers)
• Banks could be hedged in dollars for the
  asset-liability management but borrowers might
  not be (e.g. personal loans, residential
  mortgages)

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Dollarization and de-dollarization in Argentina

• Dollarization has a long history in Argentina as
  a result of high inflation since the 1970s
• The dollar became the currency during the
  hyperinflation in the 80s
• In the 1990s, with the convertibility regime,
  dollarization increased in the banking system and
  it survived a critical test the 1994 Mexican
  Crisis
• There was an explicit policy to move towards
  dollarization in the 1990s
• De jure de-dollarization after the 2001 crisis

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Some stylized facts of dollarization in Argentina

• Dollarization has been a one way street, very
  difficult to reverse
• The payments system has worked mainly in pesos,
  even during the crises
• The interest rate differential never disappeared
  for deposits in pesos and dollars during the
  period of convertibility
• Lending interest rates in pesos remained
  extremely high during that period, why?

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Argentina
econviews
Dollarization in the banking system increased
over time, especially once deposits stabilized in
the late nineties
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Argentina
econviews
Prior to the crisis they reached 60 of the total
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Argentina
econviews
Checking accounts and most transactional balances
have remained in pesos
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Argentina
econviews
The interest rate differential between pesos and
dollars never disappeared. Both rates increased
at times of crises, but peso rates increased more
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Argentina
econviews
Ex-post real interest rates in pesos remained
very high
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The First test on Convertibility The 1994
Mexican Crisis and its impact on Argentina

• The Mexican devaluation generated fears of
  devaluation in Argentina
• Deposits fell by almost 20 in just three months
• Initially the run was stronger on peso deposits
  (flight to quality) but then it spreaded to
  dollar deposits as well
• The central bank provided liquidity to the
  banking system and partially insulated the impact
  on credit to the private sector
• The bank panic was stopped without restraining
  convertibility

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econviews
Deposita fell by 20, initially pesos, then
dollars, then free fall for all
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econviews
The Central Bank financed 70 of the fall in
deposits and minimized the impact of credit
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The First test on Convertibility Implications
of surviving the Mexican crisis

• It increased the confidence in the hard peg
  regime as a policy alternative
• It promoted more dollarization of the economy,
  and in the banking system
• It increased the awareness about the importance
  of improving the ability of the central bank to
  act as lender of last resort
• It created the case for full dollarization in a
  response to a possible crisis

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Fixed exchange rates and monetary policy in
dollarized economies Lessons from Argentina

• The quantity of money was demand determined
• The central bank was able to affect the amount
  of credit in the banking system through reserve
  requirements and the provision of liquidity.
• Convertibility did not eliminate the foreign
  exchange rate risk, as it remained a differential
  between similar deposits in pesos and dollars
• The ability to act as lender of last resort was
  limited by the amount of international reserves

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The collapse of the banking in 2001/02

• There was a run on the currency and on deposits
  could not be contained with international
  reserves. No real lender of last resort
• The default on public debt weakened the banks
  balance sheet
• Flight to quality meant capital flight
• The devaluation was all but unavoidable, but had
  huge impacts on the banks and non-financial
  sectors balance sheets.
• Foreign banks were not ready to bring financing
  from abroad due to changes in rules of the game

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econviews
There were no enough financial resources to
withstand the attack on the currency and the bank
panic of 2001 and banks reduced credit
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Some stylized facts of dollarization during the
period of the hard peg in Argentina

• Run on the currency became run on banks
• Was dollarization a key reason for the crisis?
• Was the fixed exchange rate in a dollarized
  economy the main problem?
• What was missing A lender of last resort?
• A credible deposit insurance?
• Could a floating exchange rate regime have
  helped to avert the crisis?

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De-Dollarization and Monetary policy in the
aftermath of the crisis
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What did Argentina do to de-dollarize the economy?

• It de jure converted dollar deposits and loans
  to pesos (at different exchange rates)
• Contracts in dollars were transformed into pesos
  at old the exchange rate (utility rates, rents,
  etc)
• A large part of the public long-term debt was
  converted to pesos and then indexed to the CPI
• New regulations has restricted banks from in
  offering new loans in dollars (only to exporters
  and importers)
• There is still dollarization for many long term
  contracts and for financial investments

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Argentina
econviews
The Original Sin Redemption?
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Argentina
econviews
The de-dollarization increased the demand for
pesos. Currency substitution in reverse
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Argentina
econviews
The banking system now works in pesos for
Deposits..
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Argentina
econviews
. And for loans
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Argentina
econviews
But private sector deposits have not recovered
their previous levels. Less financial deepening
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Monetary Policy Where does Argentina stand today?

• Is Argentina is trying to target
• Inflation?
• The real exchange rate?
• The level of International reserves?
• Interest rates?
• The central bank sets a target for M2.

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econviews
Prices
Inflation is under control but remains in the
two digits
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Monetary Program
econviews
The Central Bank targets the growth of M2
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Monetary Program
econviews
Money supply is controlled by issuing Central
Bank bills
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econviews
The stock of central bank debt is rising
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Interest Rates
econviews
Policy interest rates have been rising, but they
are still relatviley low.
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Argentina
econviews
Real interest rates are now very low
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econviews
Monetary Policy
The appears to be undervalued
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Implications for Monetary Policy Where does
Argentina stand?

• Flexibility in the exchange rate (dirty float),
  with a band for the nominal exchange rate
• The central bank sets a target for M2.
• Central bank controls the money supply (M2)
  through sterilization combined with capital
  controls
• Policy interest rates have been gradually rising
  though they remain below inflation
• Monetary policy basically accommodates inflation

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Lessons from Argentinas dollarization and
de-dollarization processes

• Dollarization is largely related to inflation
  and macroeconomic policies, but governments can
  affect it through policies,
• Restrictions on dollar deposits and lending
• Use of indexation as quasi-currency
• The Argentine de-dollarization process has not
  yet extended to saving instruments
• and it has not been tested since the crisis, so
  far it is still smooth sailing
• Currency substitution could be reversed if
  macroeconomic conditions change.

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Implications for and questions about Monetary
Policy in Dollarized Economies

• Argentina so far has managed to use monetary
  policy by targeting the money supply
• Low interest rates have helped the recovery from
  the crisis
• The exchange rate remains competitive
• Inflation is under limited control
• But less dollarization in the banking sector
  does not necessarily imply that there is less
  currency substitution in the economy.
• And the long term capital market still works
  largely in dollars

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Thank you!