DP3399 | Sovereign Default By Argentina: 'Slow Motion Train Crash' or Self-Fulfilling Crisis?

Publication Date

20/05/2002

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Abstract

To check hyperinflation, Argentina pegged the peso at one US dollar in 1991. This stopped inflation in its tracks: but, with the rise of the dollar against the Euro and the substantial devaluation of the Brazilian real, the peso became increasingly over-valued leading to a significant country-risk premium on Argentine dollar liabilities as devaluation with ?pesification? was anticipated. Here, we apply the Ozkan and Sutherland (1998) model of over-valuation and currency crisis to analyse three scenarios: (i) that Cavallo unnecessarily delayed devaluation, (ii) that the delay was reasonable, and (iii) Cavallo?s view, that the peg should have been preserved but was destroyed by self-fulfilling panic. In conclusion, we argue that, as the costs associated with devaluation and default are largely determined ex post, so the appropriate interpretation depends on how the crisis is handled.