Why the dollarization proposed by Milei is unfeasible according to MIT

In a recent paper prepared by the Massachusetts Institute of Technology (MIT)the Argentine economist Ivan Wering warns about the current conditions of the Argentine economy and points out why the dollarization proposed, among others, by the pre-candidate for president of the Libertad AvanzaJavier Milei They are not adequate for the development of the country.

in writing “Dynamics of dollarization”, the economist and his two co-authors, Tomás Caravello and Pedro Martínez-Bruera, raise previous cases of dollarization carried out by countries such as Ecuador and Zimbabwein addition to the de-dollarization case that faced Panama. Taking these experiences into account, the paper analyzes the risks and problems involved in carrying out this type of proposal in a context of lack of credit and a shortage of dollars in the Central Bank’s reserves.

The report points out that, beyond the simple concept of exchanging pesos for dollars at the exchange rate that would occur at that hypothetical moment, it would be necessary to think about the substantive issues that this step would entail. According to the analysis, a measure of this type in a context of a shortage of dollars can lead to a “shock”, which implies a fall in consumption, a currency that is appreciated as a result of the change of sign, which would have repercussions in a sharp drop of wages. Also, an initial fall in prices is estimated, which is followed by a gradual appreciation and a positive injection.

It is for this reason that the authors describe that a dollarization in the current context of lack of foreign currency would lead the economy to a recession in the first instance. By maintaining nominal rigidities, the economy would enter a recession first, even if prices and wages are allowed to adjust flexibly based on the shock. Beyond the fact that a recovery in activity may come, the inevitable destiny turns out to be the stationary state. That is, a strengthening of the economy without any growth.

Finally, Werning’s paper warns, of course, that, beyond the effects of the macro, often left aside, there are also the usual costs: such as the loss of independence of monetary policy. “The cost of losing an independent monetary policy is enough that of a fixed exchange rate regime or monetary union”, constituted by Werning.

On the basis of an “open economy macromonetary model” it was concluded that dollarization with a shortage of dollars causes a “sudden stop”, a concept inspired by an article by the late Rudi Dornbusch (MIT) and Alejandro Werner about Mexico. There he recounted that “it is not speed that kills, it is the sudden stop”. “The consequences are that, if prices and wages are completely flexible, we need a sharp real devaluation, a fall in the price of non-tradable goods and wages in dollar terms. Then prices and wages will rise to their steady state,” Werning predicted, adding: “Then the initial recession is worse, of course, but we’ll still have inflation.”

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