Implications of Argentina’s dollarisation experiment

By Andreas Charalambous and Omiros Pissarides

The calendar marked December 10, 2023 when, having just won the election based on an extreme “liberal” agenda, the economist Javier Milei entered the office of the president of Argentina.

His economic manifesto was characterised by analysts as “anarcho-capitalist”, an apt name given that its main elements included a steep reduction of government spending and the unilateral adoption of the US dollar as Argentina’s national currency.

Not surprisingly, the disenchantment of the electorate, due to the economic hardship caused by previous governments, was a key factor behind the success of President Milei. Indicatively, we note that Argentina’s inflation has reached 210 per cent, while the country has participated in an IMF support programme since 2022.

President Milei’s experiment is being observed with both caution and scepticism. The effort to dollarise the economy is of particular interest, given that other countries facing the problem of uncontrolled inflation are also considering adopting similar strategies.

An identical approach has been proposed for the Turkish Cypriot economy. Some analysts argue that, with the unilateral adoption of the euro, the problem of inflation, which at times exceeded 80 per cent, could be successfully tackled. This topic has institutional dimensions related to the EU acquis and the policies of the ECB, as well as political dimensions that fall outside the scope of the present article.

Focusing the analysis on economic dimensions, the following may be noted.

The primary aim of such a policy is the immediate and drastic reduction of inflation through a restrictive monetary policy. Within such a context, it should be noted that in practice the supply of money, and by extension interest rates, depend on the ability of an economy to generate surpluses in its external transactions. However, economies with high inflation experience competitiveness problems, since their exports are effectively more expensive and their imports cheaper, and, as a result, deficits in foreign trade.

Therefore, for such an undertaking to be effective, it must be accompanied by a “hard” macroeconomic policy (restrictive fiscal policy, wage fixation, etc.) in order to lead to a drastic reduction in inflation and an improvement in competitiveness. Without a restrictive policy framework, a unilateral adoption of a foreign currency (dollar, euro) would become ineffective.

The combination of tough fiscal and wage policies in the absence of basic macroeconomic policy instruments would result in achieving the goal of reducing inflation, but at a high cost to growth and social cohesion.

For this reason, as well as due to the lack of a parliamentary majority, the efforts of the present government of Argentina would be very difficult to succeed. According to reports, President Milei already appears to be abandoning dollarisation in favour of a large devaluation of the exchange rate. However, such a policy approach also creates social costs that may become unsustainable without broad political support and social consensus, demonstrating the difficulty of addressing accumulated mistakes and populist policies of the past.

Controlling inflation requires the use of all policy instruments, including monetary policy and exchange rate policy, implemented in a consistent manner and with a long-term horizon in order to avoid adverse effects on growth and social cohesion.

Andreas Charalambous and Omiros Pissarides are economists