Argentina: Cavallo, lope for disaster?

ABSTRACT

This paper analyses the latest stabilization effort in Argentina, the Cavallo Plan (named after its mentor, Domingo Cavallo). The analytical framework is the tradeable - non tradeable textbook model, also known as the dependent economy model, from the Australian trade literature. The model is extended to include the effect of real wages on aggregate demand, and therefore on activity. A Phillips curve description of inflation is also added. It is shown that, by moving from a floating to a fixed-exchange rate regime, the Argentinian economy attained domestic equilibrium, at the cost of balance of payments equilibrium. The paper shows that the ensuing trade deficit may lead to a classical run on reserves, forcing the return to floating exchange rates. In the process, the economy will go through a complete economic cycle, returning to inflation.

KEYWORDS:
Inflation; dollarization; currency crisis