One issue is the lack of fiscal institutions to save during good times, reduce debt, and establish greater credibility of debt repayment during bad times. The federal system with important subnational expenditure responsibilities but limited subnational revenue responsibilities also hampered incentives for fiscal probity at the subnational level.<sup>30</sup> Federalism and national politics interacted through the use of regional distribution of funds and/or regional pattern of reforms to secure support from small, over-represented provinces to establish coalitions for reform (Gibson and Calvo, 2000; Calvo and Murillo, 2008).

On the side of monetary policies, as the situation deteriorated in 2001, the government may have “doubled its bets” on the convertibility plan, but it also sent mixed signals as it tweaked the currency board at the margin (“fiscal” devaluation and introduction of the euro) and tinkered with the institutional arrangements (questionable dismissal of the Central Bank president). One issue that is often under-emphasized in the “post-mortems” of the crisis is the double digit unemployment rate that emerged in the mid-1990s and persisted even during the post-Tequila crisis growth period. As established in a classic paper,<sup>31</sup> signaling a tough stance on an exchange rate peg can actually lower the future credibility of that pledge in the face of persistently high unemployment.

What would a credible policy package have looked like to avoid the crisis? It is not at all clear. Recall the three criteria laid out in the introduction: (i) the policy has internal logic and rationale and appears to have the right magnitude to achieve its goals; (ii) the policy is based on reliable data and trusted institutions; and (iii) the policy is consistent with a longer-term vision or strategic direction. On the fiscal policy front, there was great uncertainty as to whether a fiscal contraction could create a confidence shock sufficiently large to reassure the private sector. Some argued that a fiscal expansion might have worked; however, given the soaring bond spreads and declining confidence, it would have been a highly risky proposition at best.<sup>32</sup> In terms of fiscal policy, determining the right magnitude or even the right direction was highly speculative. There was reliable data; however, political and administrative institutions were losing credibility throughout the year, as discussed above. Some have suggested that a shift in strategic direction was needed, perhaps abandoning the currency board or moving to full dollarization. Perry and Servén (2004) suggest that the currency board should have been abandoned to allow for real exchange rate flexibility, but this should have been done in 1997 or early 1998 when the economy was still growing. De la Torre et al (2003) suggested that one way out might have been dollarization of the stocks of assets and liabilities with “pessification” at the margin with the gradual introduction of a new currency outside of the convertibility regime. This gradual approach might have worked – at least as a preferred form of crisis resolution – but might not have avoided the currency crisis itself. In brief, with so much of the credibility of macroeconomic policy riding

> 30 See Saiegh and Tommasi (1999) for a transactions cost analysis of subnational finance in Argentina.

> 31 See Drazen and Masson (1994).  The model deviates from earlier signaling models where policy makers signal their “type” by taking a strong stance.  Instead it is the policy itself, rather than the policy maker, that loses credibility over time when negative economic conditions persist.  The authors test their model for countries participating in the preEuro fixed exchange rates of the European Monetary System (EMS).

> 32 The IMF’s own retrospective looked into this possibility that a fiscal expansion might have improved the situation. Their empirical estimates show that it would not have worked. See IMF (2003), Box 9.

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