Understanding the Different Positions in the Dollarization Debate

In my last post, I broke down how dollarized economies in Latin America have managed to secure a lender of last resort. In this post, I'm diving into the debate among monetary experts about whether it’s a good idea to dollarize the Argentine economy.

The arguments against dollarization can be classified into two types: (1) those falling into the Nirvana Fallacy and (2) differences in the assumption of institutional credibility that argentine politics can create.

The Nirvana Fallacy

If it weren’t because of its significant presence in the dollarization debate, talking about the Nirvana Fallacy would be unnecessary. But contrasting the real-world constraints of dollarization with the benefits of an ideal but unattainable central bank is falling right into the Nirvana Fallacy trap. It's clear that, in theory, a perfect central bank is superior to practical dollarization. It’s also clear that the picture-perfect central bank theory can paint doesn’t exist in the real world.

A sensible evaluation of dollarization must be grounded in the realistic and attainable alternatives a country face. For instance, Argentina isn’t deciding between dollarization and a top-notch central bank. The array of options Argentina has on the table consists of (a) dollarization and (b) a highly erratic and inefficient central bank.

Precise monetary policy is like wielding a scalpel, but all Argentina has is a chainsaw.

Here is Demsetz (1969, p. 1, emphasis added) on the Nirvana Fallacy:

The view that now pervades much public policy economics implicitly presents the relevant choice as between an ideal norm and an existing "im- perfect" institutional arrangement. This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements. In practice, those who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient. Users of the comparative institution approach attempt to assess which alternative real institutional arrangement seems best able to cope with the economic problem; practitioners of this approach may use an ideal norm to provide standards from which divergences are assessed for all practical alternatives of interest and select as efficient that alternative which seems most likely to minimize the divergence.

The Credibility Assumption

A widespread anti-dollarization stance goes like this: "If we push for solid, credible reforms, then there’s no need to dollarize. Other countries like Chile, Peru, and Colombia have pulled it off, so we can too."

I agree that dollarization might not be necessary if credible, lasting reforms are enacted. However, this argument hinges on the assumption that Argentina can build credibility. Given Argentina’s history of institutional chaos, I think it’s reasonable (that is, realistic) to question this assumption.

The credibility issue in Argentina operates on two propositions:

• Proposition 1: The political system lacks credibility.

• Proposition 2: The political system can’t create credibility.

Both proponents and opponents of dollarization agree on Proposition 1 but differ on Proposition 2.

Those against dollarization assume (perhaps implicitly) that Argentine politics can generate credibility. Those in favor of dollarization believe that (considering the country’s history) it’s unlikely that, at this point, credibility can be built. Advocates see dollarization as a means to “import” credibility and lasting reforms. Remember, dollarization outlasted Rafael Correa, the most popular politician in decades in Ecuador.¹

Let me emphasize a key point: dollarization is an institutional reform first, and a monetary policy reform second.

We can’t ignore Argentina’s history. Since 1945, Argentina has grappled with a yearly equivalent inflation rate of 60%. Take a moment to ponder this. High and volatile inflation has plagued every political party, democratic or otherwise. Every conceivable monetary policy design failed to control inflation; the convertibility of the 1990s is the only exception. Even the fancy inflation targeting implemented by a Dream Tema of Ivy League economists set during Macri’s presidency led to another monetary crisis for Argentina.²

Laws passed by Congress are quickly undone or ignored when the Executive Branch deems it necessary, while the Judiciary either can’t or won’t act to shield citizens from the State’s encroachment on their rights. In a nutshell, there’s no evidence that Argentina today can establish credibility. Arguing that structural reforms can stave off dollarization assumes that institutional chaos isn’t a problem.

To be clear, what I'm saying is that there is no proof that Argentina’s economic policy can generate credibility. Thus, the ultimate basis of dollarization critics’ arguments is an assumption, not a verifiable fact. Given Argentina’s history, those opposed to dollarization should explain how Argentinian policymakers can create long-lasting robust credibility. Otherwise, their argument holds no water.

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• The original Spanish version of this post can be found here.

• Next: Is Dollarization unnecessary due to its initial conditions?

1. See this paper on “Dollarization as an Effective Commitment Device” by Emilio Ocampo.

2. You can read more about this here.