Exchange Rate Stabilisation
Argentina in 1991 and Greece in 2001 effectively entered exchange rate stabilisation programmes. In the case of Greece, of course, the notion was that it was taking part in a full and permanent currency union. The idea, however, that there was economic convergence with the rest of the eurozone as part of an optimal currency area was fiction, as I shall discuss later. Essentially, it was a currency peg like Argentina’s, with an unreformed economy.
Several studies of exchange rate stabilisation programmes have concluded that they tend to be effective at curbing high inflation, but have dangerous side effects, especially when essential reforms are postponed. They should be used as a short-term emergency measure by a government determined to use the breathing space created to reform the public sector and improve the supply-side. In practice, complacency often creeps in, as the economic data in the first couple of years can be flattering. This was certainly the case in Argentina and Greece.
A common pattern is
1) Real appreciation of the exchange rate
2) Investment and consumption boom
3) Deterioration of external accounts.
