Let's not insist with a Round Square

In Argentina, given its history, when it comes to choosing a new monetary regime the optimo optimorum is not attainable. We are stuck in a world of second best options.

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In a brilliant essay totally unrelated to economics, José Ortega y Gasset, the celebrated Spanish philosopher, addressed the problem of confusing ideals with realities:

“Ideals are things recreated by our desire—they are desiderata. But what right do we have to consider the impossible, to regard a round square as an ideal? … Perhaps what most distinguishes the childish mind from the mature spirit is that the former does not recognize the jurisdiction of reality and replaces things with desired images.”

These reflections are relevant when it comes to deciding which monetary regime can best deliver stability and sustained growth for Argentina. Insisting with an unattainable ideal will not contribute to the best outcome.

A frequent error in the debate is the nirvana fallacy, which involves comparing the costs and risks of an official dollarization regime (as I defined it here) with those of an ideal but unattainable peso-based regime (such as those in Peru or Uruguay). The correct approach would be to compare them to those of realistic alternatives. As I have argued in another article, the notion that in Argentina we can have a competent and independent central bank is chimerical. Any regime based on such assumption is doomed to fail.

Also common in the debate is the “straw man” fallacy, which consists of imagining a dollarization scheme that doesn’t work (but also doesn’t resemble any dollarization regime ever adopted anywhere in the world) and concluding that it is not viable under any format. It would be more useful to imagine how to make dollarization work, because there is no doubt that Argentina needs a change in its monetary regime. If we insist with the peso, sooner or later, some government will resort to the old trick of printing money to finance excess government spending, and we’ll once again find ourselves facing high, persistent, and volatile inflation.

Given that we live under a democratic regime with periodic alternation of power (the best possible political system), extrapolating into the future the fiscal adjustment that has taken place since December 2023 would be a dangerous mistake.

Choosing a monetary regime involves a trade-off that requires estimating the probability of alternative scenarios. To simplify, let’s imagine two monetary regimes: one based on the peso (R AR$) and another based on the dollar (R US$). Let’s also assume there are only two possible states of nature in terms of stability and growth: a good scenario and a bad one. For simplicity, we could express the expected value of each regime as follows:

Where EM is the bad scenario and EB is the good scenario, p1 is the probability of EM under the peso regime (AR$), and p2 is the probability of EM under dollarization. Let’s also assume that in a highly de facto dollarized economy seignorage revenues are similar to the transaction costs generated by bimonetariety. Then the decision simply boils down to comparing the expected value of both regimes, i.e., E (R AR$) versus E (R US$).

Let’s also assume that EB (growth with stability) is similar under both regimes. If this is the case, the exercise requires quantifying the first term of both equations. For a peso-based regime, we have 80 years of evidence. Since 1960, Argentina is the country with the largest number of years with an inflation rate among the highest in the world and a decline in GDP. If history is any indication, p1 is significantly greater than zero and higher than the global average.

What might a bad scenario under dollarization look like? In Argentina we never had a proper dollarization regime. The closest thing was the convertibility regime during the 1990s, but as I have explained elsewhere it is a poor proxy. Ecuador’s experience over the past 20 years provides a better answer to the question. During most of this period, it adopted the type of populist policies that have been typical in Argentina.

What was the result of this experiment? Price stability with an average annual inflation rate of 2.7% and an annual growth rate in GDP per capita of 1.7% ( in line with the average for Latin America). By comparison, during the same period, with similar populist economic policies and facing the same external shocks, Argentina’s respective figures were 48% and 0.9%.

If we take a longer term view of Ecuador’s history under both regimes the results are as follows:

In other words, lower and less volatile inflation and more growth and less volatility under the dollarization regime that with the sucre.

In the case of Argentina, the worst values for both variables under the peso regime coincided in 1989, when the average annual inflation rate reached 3,080% and per capita GDP fell by 7.7%. In Ecuador, no such correlation occurred. If we assume that any annual inflation rate above 50% is equally pernicious, the worst combination under the sucre regime occurred in 1999, the year before dollarization, when inflation averaged 55% and per capita GDP dropped by 6.4%. The following table shows the worst and best years under each regime:

Another way to quantify the best and worst scenarios under peso and dollar based regimes is to calculate, for the period 1946–2024, the percentage of time that Argentina and Ecuador experienced: a) an annual inflation rate above 8%, b) a fall in GDP per capita, c) both simultaneously. For Argentina, I take the convertibility regime (starting in 1992) despite being a poor proxy for dollarization.¹ For Ecuador, I assumed the dollarization regime started in 2001. I excluded the year 2002 for Argentina and 2020 for both countries. The following table summarizes the results of this exercise:

The history of both countries strongly suggests that the worst scenario in terms of inflation and a decline in GDP per capita is more likely under a regime with their own currency. In other words, for both countries, p1 > p2. Moreover, in absolute magnitude, such scenario was also worse in both Argentina and Ecuador, E (R US$) > E (R AR$). Therefore, it would be advisable to dollarize.

The simple analysis outlined above has obvious limitations but serves to illustrate the problem faced by policymakers.

To conclude, given the current circumstances, no monetary regime that can be realistically adopted in Argentina is free of risks and/or macroeconomic costs. None can guarantee us nirvana. As the table above shows, for decades, an economy based on the peso has alternated between suboptimal equilibria in terms of stability and growth. Except under convertibility, it has been impossible to have a period of price stability and growth lasting more than five years.

Ultimately, choosing a new regime involves a difficult trade-off. Even if any analysis suggests that one regime is preferable to another for the economy as a whole, it does not necessarily mean that it will also be preferable for policymakers. This is another factor to consider when assessing the likelihood that, eventually, the government will opt for a dollarization regime.

1. Given inertial inflation, the de facto start of the dollarization regime is one year after its de jure start. As to its end, in the case of Argentina it can be argued that the Convertibility regime ende at some point between April 2001, when the president of the Central Bank was fired, and June 2001, when the Convertibility Law was amended.