22 devaluation of the Brazilian real in 1999 (as Brazil is Argentina’s largest trading partner), the persistent rise of the dollar against European currencies and the yen during 19962001, and the freeze in emerging market credit flows.

The currency board brought a significant real appreciation in the peso. As shown in figure 3, if consumer prices are used to deflate, the real effective rate -- weighting by trade turnover (exports plus imports) with Argentina’s 8 largest trading partners -- approximately doubled from its level in the late 1980s to its level in the mid-1990s under the currency board.<sup>10</sup> Perry and Serven (2002) argue that through 1996, important gains in relative productivity in the tradable goods sector warranted the gains in the real exchange rate.<sup>11</sup> More generally, improvements in the domestic economic environment in the 1990s likely warranted a higher real exchange rate than in the late 1980s when economic disarray discouraged investment and exports.<sup>12</sup> Moreover, if producer prices are used to deflate, there was nowhere near as much real appreciation. Thus, from the 1987-88 average to the 1993-95 average, whereas the consumer-price deflated real exchange rate rose 75 percent, the producer-price deflated real exchange rate actually fell by 1.2 percent.<sup>13</sup> On the cpi measure, as shown in the figure, there was a period of real exchange rate decline from 1994 to 1995, reflecting the real appreciation of Brazil’s currency under the fixed rate of the Real Plan as well as dollar weakness internationally in 1995. Conversely, by 2001 the rise in the dollar’s international strength and the sharp devaluation of the Brazilian real boosted Argentina’s real exchange rate back to the peak reached in the first half of 1994.

10 Excluding China, for which consumer price time series are incomplete. The weights, based on trade in 2000, are: Brazil, 39 percent; United States, 12 percent; Chile, 9 percent; Germany, 6 percent; Spain and France, 5 percent; Uruguay and Japan, 4 percent (IMF, 2001).

11 Japan’s historical experience is a prime example of justifiable real appreciation of the currency supported by a rise in productivity in the traded-goods sector (the “Balassa-Samuelson” effect). However, in the underlying model used by Perry and Serven (Alberola, Lopez, and Serven, 2003), the use of the ratio of consumer prices to producer prices as the proxy for the rise in relative productivity of tradables to nontradables in comparison with other countries (the variable for the Balassa-Samuelson) is problematical. There would seem to be strong circularity in this approach. An appreciation of the real exchange rate tends to reduce traded goods prices relative to those of nontradables. It is easy to imagine an unwarranted appreciation of the exchange rate that occurs with no change in the relative physical productivity of tradable and nontradable sectors. Using the consumer price relative to the wholesale price as the proxy for relative physical productivity will falsely show a warranted real appreciation in such a circumstance. Moreover, much of the important gain in productivity in the early 1990s occured in the non-tradables sector (e.g. from privatization of utilities), again casting doubt on the Perry-Serven interpretation that in this period the Balassa-Samuelson effect dominated.

12 This type of gain would warrant a rise in the real exchange rate even if there were no change in the relative productivity of the tradable and non-tradable sectors but instead a productivity gain in both. 13 Calculated against the same 8 trading partners (from IMF, 2003). For some trading partners only the wholesale rather than producer price is available.