Macroprudential Policies In Argentina – A Closed Emerging Economy
Abstract
The research environment of this paper explores three published academic journals that have been conducted on the use and effect of macroprudential policies in emerging economies and financially closed markets. Such policies are used in order to prevent a financial crisis and negative economic outcomes, which appear in the abstinence application of macroprudential policies. The Aguirre and Repetto (2017) paper appraise the correlation between the financial system and macroeconomic performance in Argentina. Ucan and Basaran (2018) present the type of exchange rate for emerging markets in order to reduce inflation, after a devaluation of the currency. And, Cerutti, Claessens, and Laeven (2015) research paper use a recent IMF survey documenting a frequent use of macroprudential policies in emerging economies. This paper examines how the absence of specific macroprudential policies brought almost the end of the existence of Argentina's currency and how their implementation impacted the economy.
Introduction
The research environment of this paper examines macroeconomic policies that arise from key externalities and market failures. These risks can arise from many factors, one of them being deficiencies in monetary policy, as well as no limits of foreign currency. Those risks will remain even when policies are being applied. Even though macroprudential policies can shape economies and discipline financial institutions, they are only used in the presence of strategic interaction of banks, fire sales, interconnectedness and market failures.
Literature Review
As an economy, Argentina has defaulted on its debt eight times and inflation has in time been very high. As referred in Aguirre et al. ’s (2017) in the early 1990s the government issued a growing share of debt in foreign currency. As the economy went through a mild recession the situation worsened when Mexican peso depreciated against the U. S dollar. That is the consequence of an expansionary monetary policy and the issuing of short-term debt instruments denominated in domestic currency attracting foreign investors. The result of recession led to multiple crises on foreign exchange and banking fronts. These were some of the reasons why since 2003, macroprudential policy, limiting foreign currency exposure of financial institutions, has been a trademark of the Argentine macroprudential framework.
High inflation that evolved in Argentina during that period can easily be explained. Ιn Ucan et al. ’s (2018) it is stated that emerging countries such as Argentina, tend to issue bonds in order to increase capital inflow for investment. The risks arising from this action is inflation risk and default risk. Firstly, issuing a bond increases a country’s money supply. This is called an expansionary monetary policy. When increasing money supply, in the short run, the domestic interest rate will decrease, as well as the domestic rate of return, causing a decline in demand for domestic assets and the demand for domestic currency. As a result, the domestic currency depreciates. Low-interest rates will make investments more tempting, increasing the aggregate demand resulting in an expansion of output. In the long run, the increase in money supply, caused by issuing bonds to foreign countries, will also cause an increase in prices due to the fact that prices are positively relative to the money supply. Prices will increase, wages will adjust, increasing the cost of production. Aggregate supply will decrease. emerging a decrease in output and driving output back to its primary stage.
Real money supply domestically will decrease due to this rise in price, causing an increase in interest rate. Overall in the domestic economy prices will go up as output interest rate and the exchange rate will remain the same. Easy monetary policy and high inflation are two of the leading causes of currency depreciation. That is why most emerging markets and financially closed economies use the macroprudential instrument, limits on foreign currency. This explanation also justifies why Argentina’s debt, held mostly in bonds in 2001.
In Ucan et al. ’s (2018) it is imprinted that in the short run, the exchange rate is determined by supply and demand of financial assets. In the long run, real factors are added to financial assets. Essentially, a depreciation, like the one that happened to Argentina’s currency, increases export while imports are decreasing. Because foreign goods are relatively more expensive exporting firms will benefit. That is because the exchange rate plays an important role in firms that are exporting goods as foreigners find Argentina’s goods relatively cheaper. In order to fix inflation, it is required to use a fixed exchange rate. Central Bank can intervene at the currency through a fixed exchange rate regime by buying or selling bonds. Since inflation is high, in order to maintain a fixed exchange rate, the interest rate has to increase. This method costs in a period of economic downturns.
In Cerutti et al. ’s (2015), IMF survey documents the use and effectiveness of macroprudential policies. In all tables, the dataset from 120 countries is being measured. In the first table, the Macroprudential Index includes all twelve macroprudential policies and has a grading scale of 0 to 12. Argentina since 2003 has been using five macroprudential policies out of the twelve. The fraction of macroprudential instruments is being controlled by the central bank. As well as the fraction of financial institution-targeted macroprudential instruments that are supervised by the central bank as of 2013.
Conclusions and Future Study
Towards the end of the 1990s, Argentina was facing the consequences of the absence of macroprudential policies. The reasoning behind the economy’s big recession was, the government's goal to increase the capital inflow of investment funds. This resulted in high inflation and devaluation of the domestic currency. The country had to take drastic measures, changing radically its macroprudential framework. Firstly, by letting Central Bank intervene at the currency through a fixed exchange rate in order to limit foreign currency exposure to financial institutions. Secondly, letting a fraction of macroprudential policies be controlled by the Central Bank, as well as a fraction of financial instruments. These policies had to be endorsed in Argentina’s macroprudential framework to avoid history from repeating itself. In order to understand the use and effectiveness of macroprudential tools in closed emerging economies, it is necessary to conduct a study that examines the use and effectiveness of macroprudential policies in advanced, emerging, financially opened and closed economies. This will allow comparing the effect of these policies for each subgroup of countries.
References
- Aguirre, H. , & Repetto, G. (2017). Capital and currencybased macroprudential policies: An evaluation using credit registry data. BIS Working Papers, 10-11.
- Cerutti, E. M. , Claessens, S. , & Laeven, L. (2015). The Use and Effectiveness of Macroprudential Policies: New Evidence. IMF Working Papers, 203-224.
- Ucan, O. , & Basaran, N. (2018). The Economics of Foreign Exchange in Emerging Markets. Financial Management from an Emerging Market Perspective, 253.
