exchange rate – the foreign asset position and relative productivity growth – can be affected by macroeconomic policies and structural reforms, we can relate this component of peso misalignment with persistent policy divergences between Argentina and the U.S., which in the long run are inconsistent with Argentina’s dollar peg.

The other two terms in the right hand side of (23) capture the peso misalignment occurring even in the absence of policies inconsistent with the peg. Thus, we may view such misalignment as reflecting the inadequacy of the peg itself. It combines two items. One is the divergence between the actual REERs of the peso and the U.S. dollar, captured by the second term on the right-hand side of (23). Since each REER can be expressed as a weighted sum of the bilateral real exchange rates of trading partners (where the weights are their respective trade shares), this term basically arises from differences between the trade structures of the U.S. and Argentina. In practice, the key difference in their trade structures concerns Brazil, who is a major trading partner for Argentina but not for the U.S.<sup>20</sup> Hence, the time path of ( _qA_ −<sup>_q_</sup> $ ) is dominated by the real exchange rate of the Brazilian real, and we should expect this term to exhibit a significant increase in 1999 due to the abrupt devaluation of the latter currency.

The rest of the misalignment attributable to inadequacy of the peg, captured by the last term in the right-hand side of (23), is just the misalignment of the REER of the U.S. dollar, which the peso inherits through the peg. The logic of this term is quite simple: absent policy divergences and asymmetries in trade structure (already captured by the first two terms in the right-hand side of (23) above), pegging to a misaligned anchor currency necessarily leads to misalignment. In practice, existing empirical studies<sup>21</sup> suggest that the dollar was overvalued after 1996-97, and thus we would expect this last term to add to the overvaluation of the peso in the final years of Convertibility.

To implement empirically the decomposition in (23) we need an estimate of the misalignment of the U.S. dollar real effective exchange rate in order to capture the last term in the right-hand side of the expression. To construct such estimate, we build from the work of Alberola _et al_ . (1999), who report multilateral misalignments for the period 1980-98 for twelve OECD currencies, by extending their sample to the period 1999-01. Figure 7 reports the estimated real misalignment of the dollar that results from this procedure. Inspection of the figure indicates that during the first half of the 1990s the dollar was slightly undervalued, but in 1996 there was a change in trend which lead to an increasing overvaluation. By 1999 the overvaluation was about 10 percent, and it rose to 15 percent in 2000 and over 20 percent in 2001.<sup>22</sup> Using Figure 7, we can calculate the decomposition in equation (23). Its results are shown in Figure 8, which reports the sources of the annual change in peso misalignment 20 Brazil accounts for 30 percent of Argentina’s trade, but only for 2 percent of U.S. trade.

> 21 See Alberola _et al_ (1999).

> 22 Subsequently the dollar depreciated by about 10 percent on a trade-weighted basis between mid 2001 and mid 2002, and further over 2003.

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