Emilio Ocampo on Dollarization and the State of the Argentine Economy

As Argentina’s economy continues to recover and rebound, transitioning to a dollarization policy may be the next step toward achieving economic revival.

Emilio Ocampo is a professor of finance and economic history at UCEMA. He has written widely on the Argentine economy and has advised President Javier Milei on economic policy. Emilio joins David on Macro Musings to talk about the current state of the Argentine economy, the present and ongoing reforms of President Milei, and the prospects for dollarization in Argentina.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Emilio, welcome to the program.

Emilio Ocampo: Thank you, David. My pleasure to be here. I'm a big fan of Macro Musings, so it's great to be here.

Beckworth: Thank you for listening and being a fan of the show. It's great to know we've got fans in Argentina.

Ocampo: Oh, yes. My only regret is that I won't be able to get my mug, because I'm far away.

Beckworth: We'll make an exception for you since you're fighting a good fight on dollarization down there. We'll make sure you get one as well. Now, we talked about your work previously on the program. We had your co-author and friend, Nicolas Cachanosky, and you, together, have written a number of articles, and we talked about a book that you had written together called Dollarization: A Solution for Argentina. It's a really fascinating conversation, and we'll provide a link to that in the show notes. We'll also come back to dollarization in the second half of our program today. Now, you also gave a paper recently at the Hoover Monetary Policy Conference this year that was titled, *Commitment Devices with Time Inconsistency Disease and Institutional Anomie: The Case of Argentina.* We'll use that to be our launching pad for our conversation today. But just before we do that, tell the listeners a little bit about yourself.

Ocampo: It's a long story, but I was born and raised in Argentina. I studied economics in Argentina. Then, I decided to go to the US. I decided that economics— I didn't want to work as an economist, and I went to the University of Chicago in the US to get my MBA. That led to a career on Wall Street that took me to New York, London. I worked for several years in finance, international finance, involving all sorts of things, including privatizations in Latin America and that sort of thing. Then, about 20 years ago, I came back to Argentina, and since then, I've been increasingly involved in more academic and research aspects. My focus has been mostly on economic history, the impact of populism on economic growth, and more recently, on monetary issues and particularly dollarization, as you pointed out.

Beckworth: Okay. So, let's talk about Argentina. I'm going to lay out some basic facts, and correct me if I'm wrong on any of them. Then, I'll maybe start asking you some questions for further details on Argentina. So, the population is around 47 million. The size of the economy in purchasing power parity terms, in terms of dollars, is $1.2 trillion. This is all according to the IMF's World Economic Outlook database for April this year. Unemployment is around six and a half, down from about 12 during the pandemic, and Inflation had been about 25% per month when President Milei came in, [but] now it's down to just over 4%. On an annual basis, it's still well over a couple hundred percent, but it's coming down. That's the big thing. So, let me start off with this question, Emilio. Has the drop in inflation, which has been widely reported— is this something that's been really recognized, appreciated, and celebrated in Argentina?

Assessing Argentina’s Progress on Lowering Inflation

Ocampo: Very much so, David. As you pointed out, last December, inflation was running at a 25% a month rate, which is, despite Cagan's definition— it's borderline hyperinflation. You don't have to go to 50% to be in hyperinflation. So, opinion polls show that inflation is, right now, not the main preoccupation of most people. Most people are more worried about employment and things like that. That was not the case eight months ago. So, yes, the answer is that this has been recognized, but you have to remember that Argentina, since 1945, has had many cycles of high inflation. The last one was not the only one. We had many, and so there's a certain amount of learning and adaptation that has taken place.

Beckworth: Just for comparison— so, here in the United States, we got really worked up and excited about the 9% inflation that we had. Now, that was at its peak, and there's a number of studies that were done here talking about 4%, somewhere in that range, being a threshold where Americans really start noticing, maybe even getting angry about inflation. Where would you put the threshold in Argentina, when people really begin to get politically motivated to do something? Is there some number, you think, that really triggers the populace?

Ocampo: I think that more than the number itself is the trend. Because right now, as you pointed out, inflation is hovering around 4%. When you compare that to 25%, you say, wow, this is a major accomplishment. Now, then, you look around the world, [and] there are 195 or 196 countries that are members of the IMF, and when you look at their inflation, nobody has, right now, a monthly inflation rate that is close to 4%, not even Zimbabwe, which was our closest competitor for many years. Venezuela, 4% a month— that’s very high, but people have the sense or have the feeling that the trend is good, that the inflation is going to come down. Now, for the last four months, it was easy to bring it down from, let's say, 25% to 4, 4.5%. It's proven more difficult to basically bring it down below 4%. So, it's kind of been stuck, but the general trend is downwards, and that is very important. People feel good about that.

Beckworth: So, there's a sense of optimism in the country?

Ocampo: There's a lot of optimism, at this time, after many years of despair. Argentina has or goes through these cycles of enthusiasm and despair, and we've had many of those. We are now in a cycle of enthusiasm and optimism, but partly because there's somebody at the helm that doesn't come from a political party. In fact, he's an economist, and he believes in free markets and freedom and et cetera. So, those of us who have embraced those ideas for a long time are quite pleased to see this type of result. I never thought that I would see, in Argentina, a presidential candidate who campaigned, quoting Adam Smith and Friedrich Hayek, for example. I was able to see that myself. I couldn't believe what I was hearing. So, yes, there's a lot of optimism at this point despite the problems. We're not in Nirvana by any stretch of the imagination. Argentina, after so many decades of mismanagement— making sure we go in the right direction is going to take a lot of effort and pain as well.

Beckworth: Sure. So, just to park here a few more minutes, if someone lives in Argentina and we've gone from 25% to 4% a month, how do people deal with it? Do they simply expect inflation and effectively have indexed— maybe not a financial contract, but they know to actively engage in trade, get rid of the physical cash? Is it just something they're used to so that it's become normal at some level?

Ocampo: Yes, it's completely normalized. If you had 4% monthly inflation in the US, people would go bonkers. In Argentina, all of the adaptability is in place. So, economic agents are pretty rational everywhere and they adapt. It's not an optimal situation, because inflation, as you know, always hurts the poorest the most, and so that is a factor. The antidote to inflation, in Argentina, has been dollarization— dollarization as a spontaneous individual substitution of the peso by the dollar. This is not an official government decision, but a spontaneous decision.

Ocampo: Because if you have pesos that— for example, last November, last October, we had 10% inflation. So, if you get your salary at the beginning of the month, by the end of the month, you've lost almost 10% of your purchasing power. So, you need to protect yourself, and the way that people have protected themselves is [by] basically dollarizing, basically exchanging their pesos into dollars. And as you pointed out, Argentina has a $1.3 trillion economy, but when you take into account the monetary base in Argentina today, converting to US dollars, [it] is about $20 billion, [so] nothing. Even if you use current prices instead of purchasing power parity, the degree of monetization, of peso monetization in Argentina, is extremely low. The demand for pesos is, let's say— let me put it this way. When you run an economy with an inflation rate of 4% a month, you cannot expect to have a strong demand for the currency. In fact, you can expect to have a currency substitution effect.

Beckworth: Yes, we'll come back to that interesting fact about the unofficial dollarization of Argentina. And as you share in your papers, a lot of those dollars are held outside of the country. And so, part of the challenge would be how to get some of those dollars back if you didn't want to dollarize. But just a little bit more on the Argentine economy, so, this paper that you delivered at Hoover— you had a really interesting figure in it where you plotted the number of years a country has negative GDP per capita growth, so the number of years in recession against the number of years with an annual inflation rate in the top decile. So, you're plotting what one might call stagnation or a misery index of sorts where both the economy is contracting and prices are going high. Lo and behold, the uncontested champion is Argentina— at least from the years 1999 to 2023. So, that's 24 years--

Ocampo: Stagflation champion.

Beckworth: Yes, 24 years of stagflation, reigning number one. So, one interpretation— I guess my initial interpretation was, "Man, that's a lot of negative supply shocks." So, when I see negative real GDP and really high inflation— well, I see both excess money creation, one, but I also see a spate of negative supply shocks. Maybe they're coming from that excess monetization, but what is it about Argentina that has led to this track record?

Exploring the Causes of Argentina’s Poor Economic Performance

Ocampo: You have to go back a little bit in history, but the problem with Argentina has been a very nefarious love affair with populism. Populism was introduced in Argentina in 1946 by Juan Perón, and, probably, this is the country where populism has been most successful anywhere in the world in terms of elections, but it's been the most unsuccessful in terms of economic growth. So, people seem to be not learning, very much, the lessons of history. There are no negative supply shocks. The negative shocks are provoked by bad policies. For example, since 2011, the Argentine economy has not grown. We're talking about GDP per capita [which] has been stagnant for the last 13 years-

Beckworth: Amazing.

Ocampo: -with this type of inflation. Now, when you look at inflation with the US lens, and you try to understand Argentina, it's a little bit more complicated. This is a small economy, not so open, and not so free in terms of capital movements. And so, you have to be careful when you draw conclusions about the growth in monetary aggregates and prices, et cetera. For example, right now we have a crawling peg in Argentina, which is a foreign exchange regime where the government or the central bank devalues the currency by a fixed amount every month.

Ocampo: In theory, when you have that sort of system, the money supply is endogenous. So, the government doesn't control the money supply. So, it's a bit more complicated, but I would say that the biggest shocks in Argentina have been originated internally by bad policies. Then, we had all of the other shocks that all of the other countries in Latin America have had. Let's say the global financial crisis in 2008. We had the reversion of the commodity cycle starting in 2012 until 2017. We had COVID. So, we get all of the shocks that all emerging market economies get.

Ocampo: Plus, our politicians have been very good at generating their own shocks and at destroying credibility. You cannot grow an economy if the government is not credible, if the promises the government makes— nobody believes in them, because investment is a forward-looking exercise, and when people have doubts about the future, about the rate of return on their investments— one of the things about inflation is that it clouds the analysis. It's very difficult to figure out whether an investment will actually yield the return that an investor expects. And if you're a large company and you have to invest in an environment that is so volatile, what is the easiest way to make sure that your return on capital is positive? 

Ocampo: Well, the easiest way is to cozy up to governments and to get all sorts of subsidies and special agreements and special deals in terms of getting foreign exchange and things like that. So, unfortunately— let me put it another way. I would say that, more specifically, a high, persistent, and volatile inflation generates and favors a culture of rent-seeking from the part of businessmen, because it's very difficult to do any sort of calculation in such an environment. And again, if we had— And I think Friedman used to say that. If you had persistent inflation, but you had a totally index economy and everybody was anticipating it, it wouldn't be as bad. But when you have high, persistent, and volatile— so you go up, down. We had 25% in December. The month before we had 11%, and now we have 4%. That's a very volatile environment. It's very difficult to make long-term decisions in such an environment.

Beckworth: And that's what your paper spoke to at the Hoover Monetary Policy Conference. The title was, *Commitment Devices with Time Inconsistency Disease and Institutional Anomie.* So, that last part must be speaking to the rent-seeking that seems to take place when you have these time inconsistency problems.

*Commitment Devices with Time Inconsistency Disease and Institutional Anomie*

Ocampo: Let me step back a little bit. This time inconsistency disease I took from Finn Kydland’s Nobel lecture, when he got the Nobel Prize for his work on time inconsistency. He coined this term, time inconsistency disease, to describe countries that have time inconsistency. We all know that even developed countries, advanced countries— there's time inconsistency in policy. That's what Kydland and Prescott proved. The problem is when you have countries that can never moderate or neutralize that time inconsistency, and it's persistent.

Ocampo: For non-economists, time inconsistency is basically about policymakers that always favor the short term. So, another way of calling short-termisms is doing things that maybe, in the short term, are good, but then in the medium to long term are really bad. Populism is, in essence, about time inconsistency. Because populist leaders try to do things like favor consumption at the expense of investment. I talk about hyperbolic discounting. You have a very high discount rate, so you place a lot more emphasis on the very short term than in the medium to long term.

Ocampo: Kydland actually singled out Argentina as the extreme case of time inconsistency. So, the thing with Kydland, he said, look, when you have time inconsistency, how do you solve time inconsistency? Well, you have commitment devices. That's the other part of the talk that I gave at Hoover. A commitment device is simply a device that basically restrains governments and constrains governments and forces them to basically fulfill their promises. I gave the analogy of Hernan Cortes when he disembarked in Mexico in order for his troops to not be discouraged. He had the ships grounded, so there was no way but to go forward, and that was a commitment device.

Ocampo: It's like, "Okay, there's no way back. We need to go forward." And so, the problem when you have time inconsistency is that you get a commitment device. If you're in the US or in another developed country with good institutions and a good track record in terms of fiscal discipline or whatever, the commitment device is, "Okay, let's have an independent central bank run by an orthodox, let's say, central banker, so we will assure ourselves that, in monetary and fiscal policy, we're not going to have time inconsistency." Now, the other element that is in the title of that paper comes in, and it's called institutional anomie.

Ocampo: That's not a word that economists are familiar with. Anomie is a term that has been used extensively by sociologists, but there was an author in Argentina that coined the term “institutional anomie” to describe a situation where the government itself, who should be, in a normal country, the enforcer of the law, is actually the main law breaker, somebody who— the executive power basically ignores the law when it suits its policies or its objectives or whatever. What does this mean, in effect? It means that, for example, an independent central bank is a chimera. It's just utopic. It's not going to happen.

Ocampo: Why? I sent you a chart, and I think, in the presentation at Hoover, I showed that there are a lot of instances of de jure central bank independence. So, the economists have gone around the world and looked at the bylaws and regulations or whatever. And so, they come up looking at how, for example, the chairman of central bank is appointed and the terms and the autonomy and whatever. They come up with an index that says de jure, by law, what's on paper, tells me that this is an independent central bank.

Ocampo: And so, you compare the chart that you were mentioning before, the stagflation chart, and then you compare the central bank independence chart, and you see that Argentina, for most of the last 63 years, which is the period on the other chart, had a de jure independence that was higher than the G7. And so, you say, wait a minute. How is this possible? On paper, these guys have an independent central bank that, in fact, has, as its main objective, price stability, but the reality is that, obviously, this bank is not fulfilling that role, and it's not really de facto independent. 

Ocampo: So, institutional anomie, what it does, is it divorces de jure with de facto. So, it divorces what the law says from what actually happens in reality. And institutional anomie is another side of the coin of populism. Because what populism does is it degrades the quality of institutions. So, one of the main aspects of republican democracies is separation of powers, and one of the main elements of populism is that the leader knows all [and] the leader interprets the will of the people, so there shouldn't be any constraints on the leader. We don't care about Congress. We don't care about the judiciary.

Ocampo: In fact, this is what happened in Argentina with populism. Our addiction to populism led to institutional anomie. On the other hand, populism itself exacerbated time inconsistency. That left us, as a society, with no commitment devices. It's very difficult, in this environment, to constrain politicians, because the typical answer that I come across is, "Oh, no, we should just pass a constitutional amendment to make sure that the central bank is independent." I said, look, governments violate the constitution all the time in Argentina. The fact that you put that on another piece of paper is just not going to change anything. Because on paper, we do have an independent central bank. So, that is, in a way, the most powerful argument, in my view, in favor of dollarization, because you run out of commitment devices. There's no way to eliminate the time inconsistency disease that is afflicting you.

Beckworth: Now, we'll come back to dollarization more in a few minutes, but the short end of the story is that dollarization would literally tie the hands of fiscal policy. It would cut off the ability to finance through the printing press, to monetize. It would impose strict fiscal discipline, but you want that when you're at this very point, where you don't have any other commitment device any longer.

Ocampo: Exactly.

Beckworth: Okay, now, going back to Argentina, though, I know, from reading the history of Argentina and other discussions, that there was a time where Argentina was one of the wealthiest countries in the world. [During] the 1920s, it was one of the top 10 wealthiest countries, and you mentioned Juan Perón— he kind of derailed that, but Argentina could have gone down a different path, correct?

Ocampo: Yes. There are many studies that did the counterfactual. Just to give you a little bit more precision— from 1900 until 1945, Argentina was consistently among the 10 largest [and] wealthiest countries in the world, as measured by GDP per capita. We have the Maddison GDP per capita series, so we can go back in history. We had a period of 45 years during which Argentina was one of the wealthiest nations in the world. In fact, Paul Samuelson once said that if anybody had asked him in 1945, when he was at the apex of his analytical abilities as an economist, to identify the country that will grow faster in the next few decades, he said, “I would have chosen Argentina.”

Ocampo: And so, something happened in Argentina after '45— and I have a graph that has become viral, which is Argentina's position in the global GDP per capita rankings, and you can see clearly that you go from being among the top 10, [then] declining, declining, declining, and now we're 70 or something. And so, there is a sense of lost opportunity. I would say that between 1900 and 1945, Argentina or Argentina's policymakers and Argentina's elites looked at Canada and Australia as comparables. Obviously, after '45, that was no longer possible. We became increasingly backward, and then, from comparing ourselves to Australia and Canada, we [then] compared ourselves to Italy and Spain and Portugal, and then to Mexico and Brazil, and now, who knows. So, the decline of Argentina is one of the most tragic stories of the 20th century.

Beckworth: -All of the potential it had and the trajectory it was on up until that time. So, you bring up all of this discussion of populism and these leaders wanting to consolidate power and control things, and it's hard for me not to think about the US elections and what certain candidates are suggesting and offering, but I'll leave it at that. Let me go back to your president, who's very free market, [and] more free market than our presidential candidates this election cycle, but President Javier Milei— and I want to talk about him for a bit and also the work that you've done with him, but I want to begin by reading an article that just came out yesterday.

Beckworth: So, this is September 25th [when] we're recording this show. Yesterday, in The Wall Street Journal, there was a great article that was titled, *Argentina Scrapped Its Rent Controls, Now the Market is Thriving.* So, let me just read a few excerpts from it. It says, "For years, Argentina imposed one of the world's strictest rent control laws. It was meant to keep homes, such as the stately Belle Epoque Apartments of Buenos Aires, affordable, but instead, officials here say rent soared. Now, the country's new president, Javier Milei, has scrapped the rental law, along with most government price controls, in a fiscal experiment that he is conducting to revive South America's second biggest economy.”

Beckworth: “The result? The Argentine capital is undergoing a rental market boom. Landlords are rushing to put their properties back on the market, with Buenos Aires’ rental supply increasing by over 170%. While rents are still up in nominal terms, many renters are getting better deals than ever, with a 40% decline in the real price of their rental properties, when adjusted for inflation, since last October." Then it says, "Milei's move to undo rent control regulations has resulted in one of the clearest cut victories for what he calls economic shock therapy. He is methodically taking apart a system of price controls, closing government agencies, and lifting trade restrictions built up over eight decades of socialist and military rule, in an effort that has upended the lives of many Argentines." So, it sounds like great results on the rental property front at least, so people can find apartments now in the beautiful city of Buenos Aires. It goes on to mention in the article that he's also undoing price controls on certain food items as well. So, let's start there. Tell us about that story.

Javier Milei’s Plan to Revive Argentina

Ocampo: Well, that story certainly wouldn't have surprised Stigler and Friedman, who wrote that classic study on rent controls. I mean, it's basic economics. What happened is that about, I think, six years ago, some legislator came up with the brilliant idea of imposing rent controls, supposedly to help people control the cost of living, and what happened was what microeconomics textbooks would predict, which is that you create excess demand, because on one hand, you have higher demand, [but] on the other hand you have less supply.

Ocampo: And one of the first measures that Javier Milei took when coming to office was to basically eliminate that, and the impact was immediate, because he not only lifted rent controls, but he allowed people to enter into rental contracts in US dollars, which is very important. Because when you enter into a contract, in Argentina, in pesos, who knows what you're going to get unless you obviously index that. At some point, indexation was forbidden. So, regulations change over time.

Ocampo: But just to give you a sense, properties in Argentina are bought and sold and quoted in US dollars, actual physical dollars. And so, for anybody who has a property and rents it out, obviously the rate of return that you expect on your property— you have to measure it in dollars. So, not only were the controls lifted, but also, the law was modified so that people can actually enter into contracts that are denominated in US dollars. So, those two measures have been a boon to the real estate market, because that not only helps the rental market, [but] it helps the real estate market as a whole, because investing in residential real estate becomes attractive again. So, that was certainly one of the most effective measures or [one of] the measures that has more visibility more rapidly, I would say.

Beckworth: This, I'm sure, has added to his popularity, and he needs that if he's going to continue to push through some of these reforms that may not be as popular. But as you mentioned, [with] inflation coming down [and] rent control coming down, all of these things have led to a new sense of optimism, which may give him some runway, still, to work with. I'm curious, though, how much power does he have? He has to go through parliament, right? Like [with] these rental laws— Could he just, by fiat, revoke them or did he have to get a vote from--

Ocampo: No, we have, not a Parliamentary system, but we have two chambers. We have senators and we have representatives, as you call them, representatives, and the lawmaking process involves both chambers. Javier Milei doesn't have any majority in either one, [and] actually, he has a minority, and that limits his ability to get Congress to approve his initiatives, but he did two things. Argentine law allows for something that is called a “decree of necessity and urgency,” which [are] the words itself. So, the executive is allowed— In a way, if you look at it from a Jeffersonian democracy ideal, this doesn't make any sense,  but it's been in the Argentine system for decades.

Ocampo: So, Milei is not the inventor of this by any stretch of the imagination. In fact, he has issued much [fewer] decrees than previous presidents, but he had a decree, and the way the decree works is that the executive issues the decree, and then Congress has a certain period of time to either approve it or reject it. And so, that decree came out immediately after he came into power. Then, after a lot of negotiation, he got approval for a law that is called the Bases Law, which is, let's say, the Foundations Law that incorporates many of the regulatory initiatives that his government has.

Ocampo: So, he's managed to build a coalition with other center-right parties because, by himself, he doesn't have any majorities in Congress, but he’s managed to do that, and he's managed to push through Congress a very ambitious and wide-ranging set of reforms. So, that's been quite remarkable. He's facing a unique situation in Argentine history. This is a president that doesn't really even have a political party. His political party is very small and was created for the election, and he doesn't have majorities anywhere in any of the chambers.

Ocampo: So, it's a very unusual situation, but he's done well in that sense, because he pushed through Congress, successfully, these two initiatives, and the question is, going forward, what's going to happen? The other thing that I would mention that is unusual is that despite the fact that the economy has been in a recession for the first six months of the year, and that inflation is coming down but is still high, the approval ratings are still very high for Milei. He has a 50%, roughly, approval rating, which is remarkable after nine months. So, that gives him firepower to deal with Congress.

Beckworth: Okay, so, what are some of the big reforms that are still ahead?

The Next Steps for Argentine Economic Reform

Ocampo: In my view— and I certainly have a bias— the biggest reform is monetary reform. I think that my argument has always been that when you have a country like Argentina, with decades of mismanagement and government intervention, you have three sets of reforms that you have to do, or four. You have to do monetary reform, fiscal reform, structural reform, and trade reform, which you could, in a way, put together with structural reforms. The question on the issue is that these reforms work at different speeds.

Ocampo: If you do a monetary reform— and we've seen it everywhere in the world— monetary reforms work instantaneously. If you dollarize or you install a currency board or whatever, that works immediately. So, the effects are felt immediately. Fiscal reform takes time, and it has to be validated every year in Congress, because you need to send a budget to Congress and Congress has to approve it. So, that takes time, and to get approval, you need political power, and structural reforms are also slow. So, the question is the timing and the sequencing of these reforms.

Ocampo: And I have been of the opinion for a long time that monetary reform is the mother of all reforms, because with monetary reform, you achieve immediate results that give you a lot of political power, and that is the power that you need to basically push for the other reforms. Milei has chosen a different approach. He's gone first with a fiscal reform that is a very short-term fiscal reform. Now, he's presented a budget to Congress, and we'll see what happens with that budget. Then, on the structural side, he's pushed for all sorts of deregulation, and et cetera.

Ocampo: So, it's a different sequencing than I would have liked to see, personally. That's one of the reasons [why] I'm here talking to you, actually, but there are many ways to skin the cat, as you know. So far, he's managed to achieve things that are very important. He has a lot of popular support— which, by the way, most political analysts were saying back in December, January, that he would be facing riots by now, and nothing like that has actually happened, and Buenos Aires is more livable now than it's ever been. We used to have all sorts of problems on the streets with people demonstrating against whatever issue they fancied, they went, and they blocked the streets and whatever. That's not happening. So, that is the situation.

Ocampo: He's pushed with structural reforms and fiscal reforms, and what is pending is really a monetary reform. And the question is, what's going to happen? Because we have a foreign exchange regime that Milei inherited from the previous government that is essentially totally contrary to freedom principles or whatever. It's kind of a Soviet-like currency regime in which you cannot transfer dollars outside of the country. There's restrictions on owning and transferring dollars in and out of Argentina, and this is not something that Milei created. This is something that he inherited, and it's difficult to lift these controls from the perspective of the government.

Ocampo: My personal opinion is that it would have been better to lift them immediately, but the government has chosen to gradually get rid of those. But that's a problem, because if you have uncertainty about the monetary reform, you have uncertainty about the future evolution of prices, because you don't know what we are going to have going forward. Are we going to have a floating regime? Are we going to have dirty floating? Are we going to have a fixed peg? Are we going to have dollarization? Are we going to have a currency board? So, there's a lot of uncertainty, and that uncertainty actually is not good. 

Ocampo: What is missing right now is the monetary reform. Because at the end of the day, if we knew that we had Milei forever— that's not going to happen. We have a democracy, and there's a change in governments, but if we knew that Milei would be— or somebody with Milei's ideas would be in government forever, we [wouldn’t] need to worry about it. But we know that the chances are that some politician will come in the future and try the same recipes, the populist recipes, as in the past. So, the question is, is that politician going to be constrained? Is there going to be a commitment device or some mechanism to basically put a limit on bad behavior?

Beckworth: Yes. Now, I think what's interesting in this story about Milei is that you and Nicolas had written a book on dollarization. This is my understanding of it, at least. Correct me if I'm wrong. You hadn't orchestrated this, but you had the book come out about the time he's running for office. He picks your book up, and he goes, "Yes, I'm running with this idea.” And so, you were elevated into fame because you were the author of the book that he was citing when he talked about dollarization. Is that a fair portrayal?

Ocampo: Yes, to some extent. He independently came up with the idea of dollarization, and by coincidence, Nicolas and I published the book roughly at the same time, but his idea was different. He wanted to dollarize Argentina and do a bank reform following Henry Simons’ original idea from 1933, and my view was to do a full reserve bank in Argentina. It didn't make any sense, and it didn't make sense to do it with dollarization. And I was working— There was a broad group of businessmen and people in Argentina who believe in dollarization as a monetary reform.

Ocampo: And we need to clarify what the term dollarization means, because it's a term that is charged with all sorts of meanings, and it's very important to be precise about what you actually mean. But I went to him and I said, "Listen, I've done a lot of work with lawyers, and we drafted a law to dollarize. We did all sorts of studies," and I went to him and I said, "Look, the Simons proposal doesn't work here. What you need to do is this and that." He listened to me and said, "You know what? I like your idea." Then, he started talking about it, and eventually, he convinced me to join his team of advisors.

Ocampo: Then, he asked me to be the person who closed the central bank, technically, which caused a lot of preoccupation among central bank employees, because they thought that I was going to torch the central bank and fire them all, but my idea was much more modest. I just wanted to convert the central bank into a good superintendency or supervisor of the banking system and to take away, just simply, the ability to print money. So, it was a bit of a coincidence, and there's nothing strange about it, because people have been thinking about dollarization for Argentina for a long time, because in a country with high persistent and volatile inflation, dollarization makes a lot of sense— A country that has shown itself to be incapable of maintaining price stability.

Ocampo: There's an article that I sent to you that I wrote last year, I think, about Milton Friedman. Milton Friedman was the first economist that advocated dollarization for Argentina in 1973. People don't know that because everybody thinks about Friedman as [the] floating exchange rates champion, but he actually favored, for countries like Argentina— You know, in 1973, he was very critical of Fed policy. Nevertheless, he said, "Look, our policy is bad, but Argentina's policy is so bad that by getting our monetary policy, they would do very well." So, as I said, you don't have to be a genius to think about dollarization in Argentina. Many people have proposed dollarization before me and before Javier Milei. So, we just updated the arguments and made the case again.

Beckworth: Well, they say that sometimes it's better to be lucky than to be smart. So, you just happened to put the book out at the right time and get your moment of fame.

Ocampo: Exactly, we were lucky.

Beckworth: Yes. Well, let’s talk about dollarization. Why don't you define it for us? Maybe talk through some of the other recent cases where it has been adopted in Latin America.

Defining Dollarization and Exploring its Historical Cases

Ocampo: I always try to be very precise about what we mean by dollarization. We need to go back. Dollarization is simply substitution of a local currency by the dollar. Then, you could talk about euroization or Australian dollarization. There's some countries that have the Australian dollar as their currency. The idea is that the local currency is replaced by another currency, and we usually give the currency three functions: exchange medium, store of value, and unit of measure.

Ocampo: You can have that substitution take place in any or all of these dimensions. For example, [with] store of value, if you're in a country with high persistent volatile inflation, how do you save? If you save in pesos, you're going to lose money, so you save in dollars. Also, the dollar replacing the peso as a medium of exchange. For example, [as] I mentioned earlier, [if] you buy any property in Argentina, you pay in cash. [If] you get any surgery in Argentina, you pay dollars, in cash, physical, with Benjamin Franklin's face. I don't know if you know this, but Argentina has the largest number of dollar bills, actual dollar bills, of any country in the world, and they're not outside Argentina.

Ocampo: The interesting thing is that they are inside Argentina. We like to say that they are under the mattress or in safe deposit boxes. So, it's a very interesting situation where banks in Argentina have a lot of dollars in their safe deposit boxes, but those dollars are not intermediated, because people keep them in a safe deposit box and they don't let the bank touch them. And the reason is that people don't trust the government to not confiscate those dollars because it has happened in the past. So, anyway, going back to dollarization, you can have what is called spontaneous or de facto dollarization, which is the dollarization that I would do.

Ocampo: I would choose to pay in dollars, I [would] choose to save in dollars, or I [would] choose to price my services in dollars. That happens in Argentina, and is very common. This is a very dollarized economy in this sense. But that's spontaneous individual dollarization. Then, you have official dollarization. An official dollarization is a government saying, "Wait a minute, we're going to give legal tender status to the dollar." Some people don't understand what legal tender means. Legal tender means that currency has the power to liberate yourself from any obligation within the territory.

Ocampo: So, you can go anywhere and you owe money and you can pay with dollars, and that is giving the dollar legal tender status. That's an official government decision. So, [it’s] very important. You have two types of dollarization. One is the one that people do that is voluntary, is spontaneous, and it's a consequence of bad policies, in a way. Then, [with] the official dollarization, the government decided to give legal tender status to the dollar. Now, even in the latter case, there are many variations. For example, in Ecuador, the government said, "The dollar is our currency and the Sucre will disappear." The Sucre was the currency in Ecuador.

Ocampo: So, the Sucre disappeared. There are no Sucres in Ecuador. There's only one currency, the dollar. You take the taxi, you pay with dollars, [and] they give you cash back in dollars. That's nothing. You go to Panama, and Panama has been dollarized since 1904, since it became independent from Colombia. In Panama, there is another currency. There's the dollar, and there's the Balboa. The Balboa is a local currency. In El Salvador, for example, the dollar has legal tender status, and the Colon survives, and, actually, Bukele gave legal tender status to Bitcoin a couple of years ago.

Ocampo: So, there's a difference between what the government does and what people do. But the reality of Argentina is that the economy is dollarized, de facto. Due to decades of monetary mismanagement, people have chosen the dollar. So, just to give you a sense, David— If you add all of the liquidity in pesos in the Argentine economy— so, you add the currency in circulation plus all deposits— in dollar terms, you get to maybe $70 billion. Official statistics tell us that the private sector has close to $200 billion in dollar cash. They don't know where they are. They're outside of the banking system, but those are the official statistics.

Ocampo: Then, we know that undeclared assets are roughly in the order of another $100 billion. Then, we have $25 billion in deposits in the banking system. So, when you add all of the liquidity in dollars and you compare it to all the liquidity in pesos, you realize that the liquidity in pesos is maybe 20% of all of the liquidity that circulates in the economy. So, how can you do monetary policy when you control such a minute portion of the total liquidity? And so, there is a cost to having a de facto dollarized economy and a monetary regime that tries to impose the peso, which is a currency that people don't like and don't want.

Ocampo: And this is an interesting thing, because if you go around Latin America, Argentina stands out as the country with the strongest anti-US feelings. There's a traditional, very strong anti-Yankee sentiment in Argentina. But as I mentioned earlier, we are the country with the largest number of amounts of dollars in the world, I think, together with Russia. So, people have chosen the dollar because the peso is a junk currency, as Mandel would call it. It's a junk currency, and so they want a good currency, and the government is stubborn and they wanted to impose this junk currency on us. But people said, "No, we don't want this currency." Now, the question everybody has in their mind today is what kind of currency Argentina will have in the future and how it's going to be backed, et cetera, et cetera. So, those are important clarifications before we get into the actual discussion on dollarization.

Beckworth: And just to be clear, dollarization makes it really hard to go back to, say, a peso. So, going to, the currency board that you had in Argentina that was abandoned in, I believe, 2001— So, in the mid to late '90s, you had this currency board. The peso was tied to the dollar, and it made it harder to break that link, but you could break that link, and then you could monetize things because there were still pesos around. But if you completely dollarized the whole economy, so no pesos anywhere, no printing press anywhere, it really would be a cost for the government to go back to the peso. That's the commitment device, right?

Ocampo: Yes. The commitment device in this case is political, because the main difference with the currency board is that with a currency board, you retain a bi-monetary system and a bi-monetary banking system. What you can do is confiscate dollar deposits to fund the government, and you can confiscate all deposits. But what Argentina did in 2001 was that if you had dollar deposits, the government said, "Oh, wait a minute. These dollar deposits— now, we're going to convert them at a below-market exchange rate." So, they confiscated $13 billion from depositors.

Ocampo: Now, when you want to go back with dollarization, it's much harder, because what you have to do is tell people who earn dollars— so, workers who are basically the majority of the electorate— you have to convince them and say, listen, when people make money in dollars, when they earn their salary in dollars, the proposition by any politician, however popular he is or she is, is to say, "Hey, you know what? Starting tomorrow, you're not going to get dollars anymore. We're going to give you these very fancy pieces of paper with the face of some national hero, and you're going to earn your salary in that currency."

Ocampo: Then, you have a revolution. People are not going to accept that. And Ecuador is a very interesting case, because they had 10 years of left-wing socialist government with Rafael Correa. Rafael Correa, who is an economist— he hated dollarization. He railed against dollarization as an economist. Then he was a Minister of the Economy when Ecuador was already dollarized, and he criticized dollarization. He said, "This is monetary suicide." Then, he became president, and he was the most popular president in the history of Ecuador. He changed the constitution to get reelected. He had control of the judiciary. He had control of Congress. He was the pioneer of CBDCs. He tried to introduce a digital currency.

Ocampo: Ecuadorian people, even the people who voted for him, said, "Wait a minute, I want my dollars. Do whatever you want, but you're not going to take my dollars." So, to confiscate deposits from wealthy people— it has a low electoral cost. To take the dollars from people's pockets, the average Joe in the economy— that's a very costly political proposition, and that's why, although dollarization doesn't totally restrain a populist politician— and Correa is a case in point— It moderates the amount of damage that they can do, because if Ecuador didn't have dollarization, they would have probably ended up like Venezuela or Argentina with hyperinflation. So, that is the argument, I would say, in favor of dollarization in countries like this.

Beckworth: Alright, walk us through how we would transition to dollarization in Argentina, given where we are there.

Transitioning to Dollarization in Argentina

Ocampo: The way that you have to do dollarization, in my view, is similar to the way that El Salvador did dollarization. In El Salvador, the Congress approved a law that said, "From now on, the dollar has legal tender status, but the Colon, which is the local currency, continues to exist, and the dollar becomes the unit of account in the banking system." So, the only Colons that will circulate in the economy are the Colons that are physical— the bills, and notes, and [the] coins. But bank money, essentially, is going to be in dollars. And so, you can go back to the bank and deposit your local currency, and it's going to be credited at the fixed exchange rate.

Ocampo: So, basically, what you do is you fix the monetary base. You don't print any more pesos. You decide, as of today, that this is the amount of pesos in the economy. We're not going to print any more pesos, we're going to fix the exchange rate of the peso to the dollar, and we're going to give the dollar legal tender. And so, people can go to the supermarket, go to a coffee store, Starbucks, whatever, and pay with dollars, or they can pay with pesos as well. At the exchange rate, it's going to be the same. So, having pesos is not going to mean that you're going to lose any purchasing power, so you can use both currencies.

Ocampo: There are political reasons to do this. Obviously, there are many issues associated with currency, nationalism, national symbol, whatever. So, you avoid that. You go with it, [and] you just say, "Listen, everybody has dollars. What we're going to do is eliminate transaction costs," because if you have dollars but they're not legal tender, that means that you have to change them for pesos, and every time you change your dollars for pesos, you incur a transaction cost, because there's a bid offer in the foreign exchange market. So, the reduction in transaction costs would be huge considering the size of the economy and the amount of dollars that we already have in circulation.

Ocampo: So, that's the way that I would proceed with dollarization. There's a whole discussion going on that says, "Well, the central bank doesn't have any dollars, you can't dollarize." That is a bogus argument, because the central bank doesn't have to retire dollars from one day to the next. The way that dollarization has been framed in this debate is as if this is a liquidation event, we adopt the dollar as the currency, we give it legal tender status, and then within the next 24 hours, we have to settle all debts in pesos into dollars. That's not the way it works. It's not a liquidation event. It's a growing concern event.

Ocampo: Let me give you two instances of how this works. In Ecuador, the president dollarized by making an announcement on TV, took two months to have a law approved by Congress, the law was approved in March, and the law said, "By June 30, the local currency is going to be worthless. So, you have to tender all of your legal domestic currency because, after the deadline, that currency is going to be worthless." Guess what? Three months went by, June 30 came, and one-third of the entire monetary circulation had not been tendered. So, if the government proceeded with this deadline that meant that you were reducing the money supply by one-third, which would have obviously had an impact on economic activity.

Ocampo: And so, the government said, "Okay, let's stretch this for another three months." So, it took nine months to exchange all of the Sucres in circulation for dollars. In El Salvador, it was different. As I mentioned, El Salvador kept its own currency and it took like two years, and if you go to the central bank today, there's an item on the liabilities side that says, "Colons in circulation." So, they still exist as a monetary liability of the central bank. So, the idea that the central bank needs to have— Some economists have said, "Oh, we can't dollarize because M3 in Argentina is 70 billion, and the central bank should have at least 70 billion to back it up because otherwise—" That's nonsense.

Ocampo: Fractional reserve banking, as you know, has worked around the world with fractional reserves. This is, in essence, the same thing. The government only has to retire the money in circulation, which is a monetary liability of the central bank, and that is maybe 0.7 or 1% of GDP. You don't have to do it from one day to the next. So, what people need to believe is that this is a credible move. You need to be credible. This whole discussion about reserves— The IMF made it fashionable to talk about net international reserves, and they take gross reserves and they subtract all sorts of short-term foreign exchange liabilities and they come up with a number.

Ocampo: In Argentina, that number is negative, and I say, "Look, to say that you have negative reserves is the same to say that I have -$100 in my wallet." The fact that I have a mortgage doesn't mean that I don't have $100 in my wallet. It means that I have a mortgage, but the mortgage is a forward-looking debt. I don't need to settle it tomorrow. And so, to use this concept of negative reserves to assess whether dollarization is feasible is absolute nonsense.

Beckworth: Okay, so, one of the challenges that's often brought up, in addition to what you just covered, is the concern about fiscal federalism. So, dollarization might tie the hand of the central government's finance ministry, but what about provinces who want to print their own money, try to get around the dollarization efforts. Is that a concern that we should worry about?

Dollarization Concerns and the Prospects for Dollarization Moving Forward

Ocampo: That's not a concern. First of all, we have a province now that, a couple of months ago, decided to print its own money, and obviously, that wasn't very successful. When you talk about provincial governments issuing their own money, what they do is issue quasi-money. They issue, let's say, a one-year bond, and the question is, does that bond have legal tender status? It doesn't, because to have legal tender status, you would have to go to Congress. But the Argentine constitution says that provinces cannot issue their own money. So, my view with this issue of provincial governments issuing quasi-money, because technically or legally they cannot issue any kind of money, is that it would be a way of reducing public spending, because if you issue 100 worth of face value of this quasi-debt, and people thought that the interest rate that it paid was too low versus whatever the risk-adjusted rate should be, [then] that would trade at a discount.

Ocampo: And so, that discount is, in essence, the reduction in public spending that you would have. That would actually have very negative political connotations. So, I'm not worried about that at all. In fact, I think that if you dollarize, and a particular province decided to issue its own currency, it wouldn't matter. You cannot alter the value of the dollar because some dinky little province in Argentina issued its own currency. People would not want that currency. So, unless you can force the people in that particular province to use that currency at face value, this is a non-issue.

Beckworth: Okay. Last question then, and that is, what are the prospects for dollarization going forward, given the politics that you see on the ground there?

Ocampo: I think that the prospects are reasonably good. I would say that, in some respects, it's more expensive to dollarize today, because the monetary base back in December was 10 billion, [and] now it's 20-something billion. So, it's 10 billion more, but the government has been very good at convincing the public, and politicians in general, that they are totally committed to fiscal discipline, and they've done something that nobody thought was possible to do. They are going to reduce public spending by 5% this year, 5% of GDP. So, I would say that the fiscal credibility today is much more solid than it could have been back in December when people had doubts about Milei’s ability to do things with Congress and whatever. He's demonstrated that he can do that.

Ocampo: And so, I think, in many respects, that is an important issue, because the fiscal side is a very important aspect of the dollarization project. I think that the reality is that you have to look back at history and see the history of Argentina. You can argue that this time is different, we're going to solve all of the problems, and the peso is going to be a mega-currency going forward. I don't believe that. I think that we need to have monetary reform. It needs to be a hard monetary reform. It needs to be a commitment device. It's a commitment device for bad governments. If we were to have, from now on, forever, excellent governments that are disciplined, and they're not tempted to print money to finance their fiscal enthusiasm, then we wouldn't need dollarization. That's nirvana. We live in the real world. And so, we need a monetary reform that takes Argentina's past into account and the proclivity of the political system to basically overspend.

Beckworth: Okay. With that, our time is up. Our guest today has been Emilio Ocampo. Emilio, thank you so much for coming on the program.

Ocampo: Thank you, David. My pleasure.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.