# 1. **Introduction**

The rise and fall of Argentina's currency board (a textbook model of a rigid exchange rate regime for more than 10 years) and the subsequent financial system collapse yield important lessons for the debate on exchange rate regimes for developing countries.' As expected, the Argentine case has already generated an extensive debate on the causes and policy implications of the crisis.<sup>2</sup> Current explanations, however, concentrate too much on the latest years and do not pay enough attention to the underpinnings of the currency board and to its implications for the financial system and the economy at large.

In this paper, we study the Argentine experience from a perspective that links money (in its function as store of value) and financial intermediation. This approach has important advantages. By organizing the discussion of the different intervening factors around a main motive, it allows us to balance the broadness of a comprehensive survey with the focus needed to extract fairly general lessons. More importantly, it enables us to highlight the role played by the currency board in the development of the financial sector during the 1990s and in the genesis of its collapse. It also allows us to better understand the nature of the currency-growth-debt (CGD) trap into which Argentina fell during the late 1990s, and how it eventually led to a currency and bank run that precipitated a devastating economic crisis.

In light of the Argentine experience, we argue that the benefits of hard pegs have been much overstated. To be sure, by providing savers with the dollar as the store of value (directly under dollarization, or via the peg under currency boards), a credible hard peg ensures nominal stability and boosts financial intermediation. But even if credible, a hard peg does not automatically lead to the emergence of alternative nominal flexibility (particularly in wages, fiscal spending, and financial contracting) to compensate for the loss of the nominal exchange rate as a policy instrument. This is particularly problematic in the case of hard peg countries that, like Argentina, do not meet the classical conditions for an optimal currency (dollar) area. Partly as a result, hard pegs do not _per se_ induce fiscal or even monetary discipline. The monetary framework of a harcd peg, although typically protected by a heavy legal and institutional armor, can be dismantled more easily than expected through the emergence of quasi-monies in response to extreme budgetary cash flow pressures coupled with insufficient nominal flexibility in fiscal spending and public sector wages. Moreover, with its credibility being a positive function of its exit costs, a hard peg creates powerful incentives for the government to raise exit costs further (re-double the bet) when the hard peg is under pressure. A paiticular way in which hard pegs endogenously raise exit costs is by fostering dollarization, including of the liabilities of debtors in the non-tradable sector-as the government would rather not adopt measures to explicitly discourage dollarization for fear of undermining the credibility of its commitment to the hard peg.

> ' See Frankel et al. (2001) for a brief history of this debate.

2 See among others, Feldstein (2002), Calvo, lzquierdo, and Talvi (2002), Perry and Serven (2002), Mussa (2002), Hausmann and Velasco (2002), and Powell (2002).

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