DP3399 Sovereign Default By Argentina: 'Slow Motion Train Crash' or Self-Fulfilling Crisis?

Author(s): Javier García-Fronti , Marcus Miller , Lei Zhang

Publication Date: May 2002

Keyword(s): multiple equilibria , regime switches , currency crisis

JEL(s): D84 , F31

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP3399.asp

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.