CURRENCY SUBSTITUTION, INTEREST RATE, AND EXCHANGE RATE POLICY; THE CASE OF ARGENTINA, 1959-1981 (DOLLARIZATION)

The existing theory of currency substitution (CS) has been cast in partial equilibrium models, most of the empirical research has been based on demand for money studies for Western Europe, the USA, and Canada, and the literature has been developed within a framework of flexible exchange rates. In Argentina, however, the phenomenon of CS or "dollarization" has not been examined despite its relevance. This country has experienced high inflation, imposed ceilings on nominal interest rates which in turn resulted in negative real ones, and has generally implemented a fixed exchange rate or passive crawling-peg policy. Therefore, Argentinians have been encouraged to substitute local monetary assets (including local currency) for foreign currency which is used as a medium of exchange, unit of account, and store of value.; The objective of this dissertation is to analyze the policy implications of CS for Argentina. The different exchange rate policies carried out from 1959 to 1976 are examined in order to determine under which type of policy CS was encouraged (discouraged). Money demand functions which incorporate the CS effect are estimated for the period 1959-1981 and their stability tested. It is then described and analyzed the liberalization economic program implemented in 1976-1981, with special emphasis on the financial reform and the active crawling-peg policy. A two-sector (real and monetary) disequilibrium macro model is introduced and applied to quarterly Argentine data from 1977 to 1981. The effect of the expected rate of devaluation of the Argentine peso on US dollar deposits in Uruguay is also estimated. Finally, reference to the Chilean and Uruguayan liberalization economic programs for the 1970s is made since they provide a good empirical example of the points presented here. Currency substitution is suggested as one of the reasons behind the failure of these programs. It is pointed out as well that the programs failed not only because of internal inconsistencies but also because of the liberalization strategy itself.; The experience of Argentina in particular, and also that of Chile and Uruguay, shows that in the presence of CS a stabilization program enhances its chances of success if it starts by: (1) undervaluing the local currency, (2) reducing the fiscal deficit, and (3) co-ordinating the interest rate and the exchange rate policies. The latter co-ordination implies that both rates should remain under government control as policy-instruments.