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Expected Effects of Financial Reforms

much lower tax rates, Argentina will be

Dollarization and the reforms to the

unable to achieve good long-term growth.

financial system proposed here would stimu-

Having misdiagnosed what caused the cri-

late economic growth in the following ways:

sis, the conventional view now misdiagnoses

how to end it. The IMF has stressed that the

· Eliminating the peso would eliminate

federal and provincial governments must

currency risk.

reduce their budget deficits before the IMF

· Allowing or encouraging "offshoriza-

will lend money to stabilize the peso. In

tion" would insulate depositors from

Argentina's current circumstances, though,

future seizures of deposits by the

currency stabilization is the mother rather

Argentine government.

than the daughter of a balanced budget. Real

· Allowing banks to issue dollar-denomi-

tax revenue has fallen because the unstable

nated notes would help them increase

peso and the freeze on bank deposits impede

their supply of reserves on hand by "cap-

trade. The currency must first be stabilized if

turing" some of the Federal Reserve

the economy is to revive and generate the

notes now held by Argentines and

higher tax revenues necessary to eliminate

replacing them with bank-issued notes.

the budget deficit. Argentina's recent experi-

The conventional

· Allowing banks to issue dollar-denominat-

ence has been that cutting spending is not by

view has paid

ed notes would reduce banks' demand for

itself sufficient to balance the budget, and

reserves by reducing their need for Federal

raising tax rates from their already high levels

almost no

Reserve notes as vault cash.

actually reduces tax revenue.

attention to

· Eliminating  reserve  requirements

Maintaining budgetary discipline has been a

Argentina's high

would allow onshore banks to extend

persistent problem for Argentina, no matter

more credit on the basis of a given

what type of exchange rate it has had. No

tax rates and the

amount of reserves, if they thought it

exchange rate system in itself guarantees budg-

drag they impose

prudent.

etary discipline, and I know of no prominent

· Total savings (deposits plus bank note

advocate of dollarization who has claimed that

on economic

dollarization would do so.57 Dollarization

issue) captured by local and offshore

growth.

banks should rise, though investment

would simply improve the chances of disci-

will take longer to recover.

pline. A formal debt rule would be desirable,

but dollarization plus the inability of the feder-

al and provincial governments to borrow in

Government Finance

international markets for some years to come

will provide an informal rule.

Currency Stabilization Precedes Rather

Than Follows a Balanced Budget

Federal-Provincial Relations

According to the conventional view,

Budgetary relations between the federal

Argentina's crisis began with an overvalued

government and provincial governments are

peso. The conventional view has paid almost

complex, not because of the economics

no attention to Argentina's high tax rates

involved, but because of the politics.

and the drag they impose on economic

Historically, provincial governments that

growth. A correct view of the crisis must

have encountered financial trouble have

place tax rates squarely at the center. The tax

appealed to the federal government to rescue

increases of January 2000, April 2001, and

them with federal funds rather than fix their

August 2001 added to an already high tax

problems themselves. They have been able to

burden and discouraged economic recovery.

do so because presidents have generally need-

Dollarization can provide a quick return of

ed the political support of federal governors

confidence in the economy and give a short-

and the governors' allies in the congress.

term boost to economic growth, but without

Federal-provincial relations have been a

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