The Fiscal and Monetary History of

Argentina 1960-2007.∗
Francisco Buera† Juan Pablo Nicolini‡
December 30, 2011

Abstract
In this paper, we use the budget constraint of the government as
a conceptual framework to account for the macroeconomic history of
Argentina between 1960 till the recent international financial crisis.
We argue that the evolution of the fiscal deficit explains most of the
macroeconomic instability Argentina experienced during the period.

∗
We would like to thank Fernando Alvarez, Guillermo Calvo, Eduardo Fernandez Arias,
Tim Kehoe, Jose Luis Maia, Rodi Manuelli, Tom Sargent and Andres Velasco for comments
and suggestions. This paper is the leading chapter of a project entitled "The Monetary
and Fiscal History of Latin America", led by Tim Kehoe, Juan Pablo Nicolin and Tom
Sargent. We thank the Inter-American Development Bank for financial support. The
opinions expressed in the paper reflect our own views and do not represent the Federal
Reserve Bank of Minneapolis or the Federal Reserve System.
†
UCLA, Minneapolis Fed and NBER
‡
Minneapolis Fed and Universidad Di Tella

1
1 Introduction
The purpose of this paper is to use the monetary, fiscal and debt experience
of Argentina during the last four decades to asses the usefulness of recent the-
oretical developments and to draw preliminary conclusions regarding policy
implications.
During the 70´s and the 80´s Argentina, as well as many other Latin-
American countries, experienced sustained fiscal deficits that led to chronic
inflation, at least three short episodes of hyperinflation, many balance of pay-
ment crisis and one defaults on international debt markets. During the 90´s,
a different picture emerged, inflation rates were the lowest in many decades,
the nominal exchange rate was fixed for over 10 years due to the currency
board in place and the fiscal deficit was substantially reduced - it became
negative in the first years of the decade. In 2001, a mayor crisis developed,
with bank runs, a large devaluation and a new default in international credit
markets - one that has not been totally renegotiated as 2010.
It has been understood for long, that sustained deficits can generate
macroeconomic instability like the one Argentina experienced. Other recent
crisis - in East Asian countries in 1997, as well as in Mexico in 1995 - drew the
attention of many to debt management issues as the main originating factor.
In particular, issues regarding indexation and maturity of government debt
play probably the most prominent role ever in debates over the explanation
of balance of payments and currency crisis. Probably one of the reasons of
this recent protagonic role of debt management has to do with the fact that
the good old bad character - the fiscal deficit - cannot be blamed in these
occasions. None of the countries that suffered in the recent crisis had at the
time a bad fiscal record.
One of the problems with this new role that the recent experiences seem
to give to the debt, is that the economic literature has very little to say about
it. Neutrality theorems - the Ricardian Equivalence being the most notable
example - are commonplace. Few models are useful in guiding the empirical
analysis and most of them have been very recently developed and not fully
understood yet. Given these limitations, this paper will not provide a deep
understanding of many of the problems posed, rather, it will be a trip over
the most important issues that the recent literature draw attention upon,
mashed with the recent Argentinian economic history. We think that the
trip is a useful one in isolating the issues that seemed to us to be key in
understanding the crisis that occurred in Argentina during the period and in

2
extracting lessons regarding policy implications.
The paper is organized in three sections. In the first one, we briefly review
the last forty years of fiscal, monetary and debt history of Argentina. The
purpose of this section is to highlight the facts that seem to us relevant in
understanding the interplay between the government debt and the evolution
of the main macroeconomic variables. Thus, both the division of the whole
period in sub-periods and the facts that will be stressed are chosen to focus
on the role of the government debt.
In the second section, we offer a tour of the Argentinian experience guided
by several attempts of the literature to understand the role of macro policy
in the economy. The common feature of the models that will serve as guide
is that the government debt, as well as the maturity and denomination,
are basically exogenous. Thus, the focus of this literature is on the effects
of certain debt features on macroeconomic outcomes. The tour will start
using the government budget constraint as in Sargent (1983) to highlight the
interactions between the fiscal policy and the monetary policy, where the
debt plays a key -but unexplained- role. Then, we will move to models that
stress the maturity structure of the debt and exhibit multiple equilibria, as
in Calvo (1995). We will also interpret the evidence using a family of models
that analyze the optimal lending policy with enforcement constraints, as in
Bulow and Rogoff (1989), Marcet and Marimon (1992) and Albuquerque
and Hopenhayn (1997). We conclude the section by considering a series of
papers that stress the role of the banking sector, as in Diaz-Alejandro (1985),
Velasco (1989) and more recently Burnside, Eichenbaum and Rebelo (1998).
In all cases, we will briefly sketch the theory and explore the evidence to see
how relevant that theory seems to be for the crisis experienced by Argentina
during the period.
A final section contains some policy implications derived by the analysis
together with concluding remarks.

2 Macroeconomic and debt evolution

The analysis of the paper covers roughly the period that starts in the early
sixties till the beginning of the last international financial crisis. As the
focus is the behavior of fiscal, monetary and debt policy, we divide this
general discussion in five periods depending on the ability of the government
to borrow in domestic and foreign markets, since this determines the way

3
fiscal and monetary policy interact.
The first period is the one that starts in 1961 and runs till 1976. During
these years, the economy was closed to capital movements. The debt as a
share of GDP was small and it was mainly domestic debt. For instance, in
the early seventies the debt to GDP ratio was around 7.5%, while the foreign
debt accounted for only 20% of that. The period was characterized by an
average fiscal deficit close to 4.8 % of GDP. Being a closed economy, the
government had no access to foreign borrowing so the deficits were financed
by either domestic debt, or seiniorage. By 1973 and 1974 the deficit jumped
to 6% while in 1975 it skyrocket to 12%. This increased fiscal imbalances
where financed by both seiniorage - 1975 is the year of the first hyperinflation
of the period considered - and by domestic debt. Thus, by the end of 1976,
the debt to GDP ratio was over 20%.
The second period covers roughly from 1977 to 1982, the beginning of
the debt crisis. This period was characterized by a substantial reduction in
tariffs and the opening of the economy to the international capital market.
Two policy changes are key to determine the evolution of the debt. The first
was the deregulation of the financial sector. This deregulation implied a free
market determined interest rate together with free entry into the industry.
These reforms, together with a deposit insurance guaranteed by the govern-
ment, are key in understanding the development of government debt for the
following decade, as we will argue below. The deposit insurance is contingent
debt of the government because in the case of a banking crisis, the liabilities
of the financial sector become liabilities of the Central Bank. The second is
the stabilization attempt launched in 1978, that included a pre-announced
crawling peg. To enforce the credibility of the plan, an exchange rate guaran-
tee was offered by the government. This period was characterized by access
to the international capital markets and the government financed the deficit
with foreign debt, mainly bank debt.
By the end of this period, a generalized banking crisis forced the govern-
ment to back an important portion of deposits. At the same time a balance
of payment crisis developed that led to a sharp devaluation of the domestic
currency. The exchange rate guarantee implied an additional burden for the
government.
Starting in 1982, the government could not comply with the debt obliga-
tions and unilaterally declared default. This event forced the government out
of the international capital market until 1991, so the fiscal imbalances had to
be financed by either domestic credit or seiniorage. This period, the third we

4
analyze, witnessed two hyperinflations and several balance of payment crisis.
A very interesting feature of this period, is that while the government did
not compile with the obligations on foreign debt, it issued domestic bonds
denominated in U$ dollars and never defaulted in these bonds. Thus, while
defaulting in some contracts, it managed to honor others. 1989 was a year of
crisis. A balance of payment crisis developed into a hyperinflation, reaching
more than 200% a month in June. A stabilization period started in July 1989
and two developments are important regarding the evolution of government
debt. The Bonex plan in January 1990, that swapped short-run bank de-
posits for long term bonds, and the Brady plan in 1992, an agreement with
creditors to end the default period.
The Brady plan is the starting date of the fourth period, in which a
successful currency board was imposed. A period of regained confidence
in international capital markets starts. The government could float bonds
abroad and after several years of stability, the interest rate paid was only a
few points above the T-Bills rate. The episode that is most interesting in
the period is the severe banking crisis developed at the beginning of 1995,
following the turmoil of international capital markets after the Mexican de-
valuation in December 1994.
The last period starts in 2000, the year in which doubts emerged regarding
the sustainability of the currency board, doubts that received confirmation
in the massive crisis that started in December 2001. A devaluation, followed
by a default in international credit market preceded the worst depression
Argentina experienced in decades. Starting in 2003, however, remarkable
growth rates in GDP followed, with higher inflation rates than in the 90´s,
but mostly below 15% a year and very stable, relative to the Argentinean
experience of the second half of the XX century.
These developments are relevant in understanding the dynamics of total
government debt, depicted in Figure 1. The figure represents total federal
government debt, including bonds, banking debt, debt with other govern-
ments and financial institutions.. It is denominated in 1996 U$ dollars. The
total debt increased substantially from 1975 and 1982, the yearly average
being 30%. This is the period where the government borrowed abroad to
finance not only the deficit, but also the ”contingent debt” that the deposit
and exchange rate insurance implied. Then, the debt crisis develops and the
debt of the government grows at a much lower rate. In fact, the debt in 1991
is slightly above the number in 1983. The changes in the stock of debt are
driven by arrears and the issuing of domestic bonds, some of them volun-

5
tary, some of them mandatory. Starting in 1991, as the government regained
access to international capital markets, the debt started to grow again, the
average yearly rate being 10%.
The persistent increase in the government debt continues until the 2001
crisis. At that point the evolution of debt is characterized by a shape in-
creased from 2002 through 2004, and drastic reduction in 2005. Following
the financial crisis of 2001, a large amount of “contingent debt” was realized
as the government decided to partially insure (ex-post) private debtors for the
exchange rate risk, they decided to assume the debts of local governments.
In 2005 the was able to reduced the value of its debt as they restructure a
large fraction of their debt in default. By the end of the 90s, the government
debt was at the value prior to the 2001 crisis.
To get an idea of the relative size of the debt, Figure 2 depicts the debt
to GDP ratio. Two main developments affect this figure relative to the one
before. The first one is obvious, GDP growth. The second, that is very
important for Argentina during the period, is real exchange rate movements
between the peso and the dollar. The GDP, as well as the peso denominated
debt, are deflated using peso price indices, while the dollar denominated debt
is deflated using the US price indices and the nominal exchange rate between
the peso and the dollar. Any deviation on PPP will affect the figure. This is
important to take into account, because there will be strong movements in
the debt to GDP ratio that are not associated to fiscal policy but to relative
price changes, and there were substantial relative price changes in Argentina
during the period considered here.
Thus, while the total debt increased from almost 20 billion to almost 50
billion from 1975 to 1980, the debt to GDP ratio actually went down. As we
mentioned above, this is because there was in fact GDP growth during the
period, but obviously not of the same magnitude as the debt growth. What
explains the behavior is a strong appreciation of the peso, so the relative
value of the dollar denominated debt went down. The sharp increase of the
debt to GDP ratio in 1982 reflects the strong depreciation of the peso. Thus,
the period is characterized by an increase in the debt to GDP ratio which is
smooth if we abstract from real exchange rate movements.
The flat portion of the figure during most of the eighties reflects the fact
that the government had little access to credit markets, a fact that is also
suggested by Figure 1. The spike in 1989 is essentially explained by a strong
depreciation of the peso and, to a lesser extent, a strong recession. The third
period is characterized by a roughly steady and lower value of the ratio.

6
Again, an important explanation of the reduction is the appreciation of the
peso and the high growth rates experienced by Argentina during the period.
As a first approximation in a decomposition of the effect of real exchange
rate changes in the evolution of debt. Figure 2.b depicts a simulate devalue
of the debt to GDP ratio. The simulation is made assuming a value for the
real exchange rate that is, for the whole period, equal to the value it had in
1991. This real exchange rare is used to value the fraction of total debt that
was denominated in dollars. The differences between the two curves are very
large.
Another important factor that explain the behavior is the privatization
of state owned companies in the beginning of the decade. The government
accepted its own bonds as a mean of payment in the auctions, so the priva-
tization process was a bond-company swap to some extend. Thus, while the
debt to GDP ratio is low for international standards, and steady, the picture
shows that sudden real exchange rate appreciations can substantially modify
this ratio to the extent that an important share of the debt is denominated
in foreign currency. This is important, because it makes a relevant distinc-
tion between bonds indexed to the domestic inflation and foreign currency
denominated bonds. In Figure 3, we plot the ratio of total debt denominated
in pesos to total debt denominated in foreign currency. As the picture clearly
shows, the share of peso denominated debt was important (about a third of
total debt) during the seventies, had a modest increase in the nineties, and
only became significant again after the 2001 crisis. Figure 4 shows the ra-
tio of non-indexed debt to index debt. This shows that non-indexed debt
was important during the late seventies, disappear during the eighties, and
there was a modest increase in the nineties. Right after the 2001 crisis, the
non-indexed peso denominated debt was replaced by dubiously indexed debt,
which is being faced out in the most recent years. In fact, the two graphs
show that essentially all of the peso denominated debt issued during the
nineties is non-indexed debt, while in the 2000s the opposite trend was true.
Overall, these pictures show that while the debt to GDP ratio was low
in normal times, albeit trending up, the exposure of this number to real
exchange rate fluctuation is important. For the most part of this period,
ninety percent of the debt was dollar denominated, which means that a crisis
that entails a real exchange rate depreciation would substantially affect that
ratio. For instance, to increase the debt to GDP ratio from 25% to 40%,
the government should have a deficit (including interest payments) 3 points
higher than the growth rate of output sustained for 10 years. A crisis that

7
conveys a 50% real depreciation - a number that is in line with the recent
experience- would achieve that change instantaneously. Again, the reason
for this is that more than 90% of the debt was indexed to the exchange rate
rather than to the domestic price level.
Another feature of the debt that is relevant for the discussion that follows
is the maturity. Recent theoretical developments have stresses the role that
short term maturity has in triggering macroeconomic crisis. Figure 5 depicts
the distribution of maturity for selected years, 1978, the year where the
increase in foreign borrowing started, 1982, the year of the banking, balance
of payments and the debt crisis, 1996, the year after the “Tequila crisis”,
and 2000, the year before the latest crisis. A clear pattern of the graph is
the change in maturities that occurred during the period. The stabilization
period of the late seventies inherits a distribution of maturities highly biased
towards short term debt. Almost a third of the debt was due within a
year, while more than 60% was due in the first four years. By 1982, the bias
towards short term debt was stronger. Following the debt restructuring under
the Brady plan, less than 10% of the debt was due in the following four years.
This reflects more the negotiations between the government and the creditors
that took into account the inability of the government to generate surpluses
to pay the debt more that an explicit policy to manage the maturity of the
debt. However, a remarkable feature is that the debt expansion of the nineties
evident in Figure 1, most of it voluntary debt floated by the government in
international capital markets, was managed to preserve a favorable maturity
structure. Thus, less than 40% of the debt is due in the following four years,
and only 8% is due in the following year.
By 2000 the maturity problem worsened somewhat. The fraction of debt
due in the following year increased to 14%, amounting to 6% of GDP. Nev-
ertheless, while substantial, the maturity problem was less significant than
that prior to the 1982 crisis.
Finally, a remark regarding Central Bank debt. During the 80’s, an im-
portant source of financing of the central government was carried out through
the financial system, essentially by increases in the reserve requirements of
commercial banks in the Central Bank. Thus, an important fraction of sav-
ings in the form of deposits financed the central government rather than
private investment. Figure 6 depicts the liabilities of the central bank with
the financial system as a fraction of the liabilities of the financial system. The
graph shows that part of the deficits during the late seventies where financed
through the financial system, but the most remarkable feature of the graph

8
is the substantial borrowing through the financial system performed during
the debt crisis. This is a key element to understand some developments of
the period 1989 to 1991. The implicit maturity structure of this debt is the
maturity structure of the financial system liabilities, mainly deposits. During
the period, the most common maturity for deposits was a week, almost never
above a month. Thus, the government was indebted with the private sector
through the financial system at very low maturities. In January 1991, the so
called ”Bonex Plan” swapped the deposits of the financial system (essentially
liabilities of the Central Bank) into 10 year government bonds. This was a
step previous to the introduction of the currency board.
In summary, the behavior of government debt is explained by fiscal policy
as usual plus three other main features. First, the realization of states against
which the government insured the private sector, such as exchange rate in-
surance and deposit insurance. To the extent that the nominal exchange
rate is devalued or the banks go bankrupt, the liabilities of the banks or of
the private debtors in dollars become partial or total liabilities of the gov-
ernment. This explains the substantial increase of debt from 1980 to 1983.
Second, fluctuations in the real exchange rate affect the value of the debt
substantially to the extent that most of the indexation is using the nominal
exchange rate. Third, an important part of the government borrowing can be
materialized through the financial sector and this option becomes attractive
when the international capital markets are closed to the government.

3 Conceptual Issues:
In this section , we very briefly discuss the main results regarding debt man-
agement found in the literature and analyze the evidence presented in the
previous section. In many cases, we will look for additional evidence to get a
better interaction between the theory, the facts and the policy implications.
We start by review the studies on inflationary episodes that use the govern-
ment budget constraint, as prominently done by Sargent (1983). We also
consider the variations on this models to capture balance of payments cri-
sis (Krugman(1978)). We then review a more recent literature that focuses
on the maturity structure of the debt as a key to understand currency and
balance of payments crisis (Calvo (1995) and Cole-Kehoe(1995)). Finally,
we sketch theoretical results derived from the theory of optimal dynamic
contracts with enforcement constraints.

9
3.1 The economics of budget constraints
Sargent (1983) uses a simple budget constraint approach to understand episodes
of nominal instability, essentially understood as inflationary episodes. It is
worth noticing though, that balance of payment crisis and most of the times
banking crisis1 are associated to inflation.
If we let  be the deficit of the governments in nominal terms, measured
as expenditures and transfers minus taxes,  and  the stock of government
debt and money, and  the nominal interest rate, then the budget constraint
of the government can be written as

(+1 −  ) + (+1 −  ) =  +   + ∆
The right hand side of the equation represents the financial obligations of
the government in the period, while the left-hand side represents the two
ways the government has to finance them, by issuing interest bearing debt or
non-interest bearing debt. Thus, sustained deficits may not lead to inflation
if the debt is managed to finance all obligations. On the other hand, if
by some reason the government is unable to borrow, then the only source
of financing is money issuing and we can therefore associate deficits with
nominal instability. The analysis of Sargent is conditional on there being a
limit on the ability to borrow and, to start with, we pursue this line here.
Then, we will come back to the issue of the limit to the debt.
Notice that we consider three sources of financial obligations of the gov-
ernment. First, we have primary deficit, i.e., the differences between current
revenues and expenditures net of interest payments. The second element is
given by the realized return of the government’s liabilities. In interpreting
this term we are implicitly assuming a model with debt of various maturities
and denominations (see Hall and Sargent, 2010). Finally, we allow for the
realization of “contingent liabilities”, ∆ , such as the transfer of the liabil-
ities of a subset of the private sector or local governments, to the central
government.
Figure 7.a illustrates the importance of the last two sources of financial
obligations,   and ∆ . The solid (dashed-dotted) line shows the actual
evolution of the government debt2 . In addition, we show the hypothetical
evolution of public debt under the assumption that  plus the interest paid
1
A remarkable exception is the banking crisis of 1995.
2
This series includes the non-performing liabilities of the government, i.e., the bonds
held by individuals that did agree to reschedule the payments in the 2005 debt swap. The

10
in the current period are the only two sources of financial obligations (dashed
line). As can be readily seen, in the 1990s and 2000s government deficit as
only a minor part of the history of public debt.
In figure 7b we plot the yearly deficit and the yearly inflation rate3 . The
story of Sargent fits the story cualitatively. The three years of nominal
instability, 1975, 1985 and 1989 are the three years in which the deficit picked.
It also seems clear that the story has severe problems in the quantitative
aspect, for instance, the deficit in 88 and 89 are similar to the ones in 61
and 81 and the inflation rate was five times higher. However, the objective
of this paper is not to account for the nominal instability, rather, we want to
analyze the potential role of debt management in triggering or fostering it.
Thus, a first approximation to the last thirty years of instability in Argentina
point to the interaction between sustained and positive fiscal deficits and the
inability to borrow. Ideally, one would like to know the determinants of the
debt limits. The remainder of this section is an attempt to point suspects
using the Argentinian experience.
A natural first step is to try to shed some light into the relevance of the
debt limit in the Argentinian case. To put it differently, was the debt limit
key in determining the events?. Some evidence is provided in Figure 7c,
where the evolutions of the deficit for Argentina and Spain4 are depicted.
While the behavior is very different until 1983, they look more similar since
then, the mayor difference perhaps being the variance. However, the variance
of the deficit does not play a crucial role in Sargent’s story. As Spain did
not go through severe nominal instability5 , it appears that deficits like the
ones Argentina had during the eighties are not enough to generate instability.
Altogether, these numbers suggest that the debt limits must be playing an
important role in shaping the relationship between the deficit and nominal
instability.6
dashed-dotted line shows the evolution of public debt under the assumption that these
liabilities will never be honored.
3
The inflation rate is defined as ln(+1  )
4
The choice of Spain is rather arbitrary. Several european countries followed similar
patterns.
5
A couple of balance of payment crisis developed in Spain that forced devaluations of
the peseta. Relative to the Argentinian experience those are very minor events.
6
Spain seems is facing difficulties now, but note that the behavior of the deficit was
better in the last 15 years than during the previous ones.

11
3.2 The BOP crisis version
The story of Sargent can also accommodate balance of payment crisis when
countries chose, as Argentina repeatedly did during the period, to fix the
nominal exchange rate. An articulated model is provided in Krugman (1979).
The story uses some version of the Purchasing Power Parity, that uses arbi-
trage conditions for the price of traded goods in open economies, i.e.

 = ∗ 
where  is the domestic price level, ∗ is the price level of the foreign country
to which the domestic currency is pegged, and  is the nominal exchange
rate. The second key component of the theory is a version of a demand for
money. We use the quantity theory, the reads

  =  
where  is the velocity of money, assumed constant, and  is the real GDP,
determined in the real sector of the economy. To simplify, let us assume that
the relevant monetary aggregate is the monetary base. From the balance
sheet of the Central Bank
 =  + 
where  is the stock of international reserves of the Central Bank and 
is the stock of domestic credit.
The first equation determines the domestic price level as long as the
nominal exchange rate is fixed. The second equation then determines the
nominal quantity of money. Thus, the total amount of nominal money cannot
be increased by the Central Bank, and any attempt to do it by increasing
domestic credit will imply a reduction of the stock of international reserves.
The story then goes like this. Sustained deficits and the lack of ability to
borrow will force the Central Bank to increase domestic credit. The increase
in domestic credit will force a loss of international reserves. To the extent
that the deficits are sustained, the nonnegativity restriction of international
reserves will eventually be binding, inducing a balance of payments crisis, a
devaluation and inflation will follow7 . Again, the inability to borrow is a key
component of the theory.
7
The nice twist in Krugman is to make the demand for money to depend on the nominal
interest rate to generate a ”run” against the domestic currency.

12
 To summarize, at a first sight the deficit seems to be the main explanation
of Argentinian crisis. Thus, a Sargent type of story fits the data and describes
the experience. Why should the debt be important? First, from a theoretical
point of view, it is important because Sargent’s analysis depends on the
country having reached the credit constraint. In the model that is exogenous,
so there is not much else to say. The interesting questions that arise are, what
does the limit depend on? and how does it get determined in equilibrium?
Second, if we compare the deficits of this period with the deficits of the
previous periods for Argentina, or with Spain, there does not seem to be
much of a difference. The key has to be behind the limit to the debt.
How does a country reach the limit? It is possible that a government
accumulates deficits for a long time so that eventually and smoothly gets
to the limit. That is indeed a possible story. Where does the debt limit
come from? Supposedly, it has to do with the present value of the maximum
surplus that the government will be able to generate in all future dates. None
of these two aspects seem to fit the Argentinian experience.
The evidence we showed on the evolution of the debt in the late seventies
suggest that it is not fiscal policy as measured by the deficit, but as measured
by the ”contingent debt” variable that explains the big increase in the debt.
The key change in the seventies was the liberalization of the financial sector
with a government deposit insurance. This increased substantially the ”con-
tingent debt”. The government guarantee represents liabilities in the event
of a bank bankruptcy.. The banking crisis of Argentina in 80 and 81 was the
event the transformed the ”contingent debt” into debt. On top of this, the
exchange rate guarantees also represent contingent debt. The devaluations
of the early eighties also increased the liabilities of the government. There is
no continuous approaching of the bound in this case8 . Finally, the debt to
GDP figures before the debt crisis where below 40%. Countries with similar
economic characteristics had no trouble borrowing way higher shares of their
output so it is hard to believe that 40% represents the present value of max-
imum future surpluses. A natural remark at this point is that the relevant
concept may not be the present value of the maximum possible surpluses,
that reflects the ability to repay. Rather, it may be the maximum that the
government would voluntarily pay, that reflects willingness to repay.
Our discussion suggests that while Sargent’s story is enlightening in sev-
8
This feature will also be discussed when we address models with enforcement con-
straints.

13
eral dimension, there are at least three issues that deserve further explanation
for the case considered. First, why there is a debt limit to start with. Second,
does it make a difference if you arrive to that limit smoothly or by a discrete
jump in the debt. To put it differently, should the constraints on debt be
related to the total amount in a given period or to the net change of the
total in a given period? Third, how relevant incentives rather than ability to
repay are in determining credit limits. We address these feature below.

3.3 The maturity problem

In the previous section we stressed the role that the contingent debt played
in substantially worsening the economic and financial position of the gov-
ernment. The government nationalized a share of the dollar denominated
private debt after the devaluation and paid an important share of the de-
posits after the banking crisis. This force the government to raise a large
amount of funds in a short period of time and made the banking and balance
of payment crisis to deepen the fiscal crisis of the government. This factor
is stressed by a series of models that focus not only on the total debt of a
government, but also on the maturity structure like Calvo (1995) and Cole
and Kehoe (1995).
The intuition behind these models is the following9 . Consider a two period
economy with a government that inherits an amount  of debt. The budget
constraint will therefore be
2
 − 1 − =0
1+
where  is the surplus of period  and  is the international interest rate.
Obviously, as the debt is positive, the government will need positive surpluses
to pay it back. For simplicity, assume away any enforcement problems. As-
sume also that max is the maximum surplus that the government can raise
without provoking a recession. Finally, assume that a recession means that
the following period no surplus can be raised.
Under this assumptions, if

 ≤ max
9
The following discussion follows Calvo very closely.

14
then the debt can all be paid in the first period. Also, the interest can be
paid the first period and the debt paid back on the second period. On the
other hand, if
max
 ≥ max +
1+
the debt cannot be paid without avoiding a recession. Thus, the most inter-
esting case is for intermediate values of the debt

max max max

  + 
1+
Assume also that all the debt is due on the first period. In this case, there are
two equilibria. The first equilibrium is characterized by positive surpluses in
the first period that covers the interest payments and part of the debt, while
a share of the debt is refinanced for the second period. The surplus of the
second period is enough to pay back all the debt. Along this equilibrium,
all the debt is paid back. The other equilibrium however, is characterized
by default. In this equilibrium none of the debt gets refinanced, so the
government is force to raise a surplus higher that max  This provokes a
recession such that the government in the second period is unable to raise a
surplus, making rational the behavior of the lenders of not refinancing the
debt.
Note that in this case the maturity of the debt can be managed to kill the
second equilibrium. If an amount equal to max is due in the second period,
then the government has automatic refinancing, it does not need to raise a
surplus larger than the maximum and avoids the recession.
This story is very attractive to understand two episodes in the period
under study.
Consider first the years before the debt crisis. As we already stressed
above, the government accumulated contingent debt through the exchange
rate and deposit insurance mechanisms. The deposits of the financial sector
where very short maturity, mostly a month. The foreign exchange rate guar-
antee started for debts of over a year and a half, but was rapidly extended to
short term liabilities too, so a share of this bail-out was short term too. The
model above can be renamed to consider contingent debt. After the bank
and exchange rate crisis, the government had to refinanced a large amount
of short term debt. At the same time, the maturity of the existing debt in
1982 had an important bias towards short term. According to Figure 5, more

15
than 40% of the debt was due within a year. Thus, the years 1982 and 1983
where years in which substantial amounts of liabilities were due. Reading
the events that followed as a representation of the bad equilibrium of the
previous model is tempting.
The second episode is the Bonex plan of January 1990. In order to un-
derstand the main forces behind this plan, let us go back to Figure 6, where
the financing of the government through the financial sector is represented.
As we already mentioned, after the default the government did not have ac-
cess to foreign capital and used intensively the financial sector. By 1989,
almost 90% of the lending capacity of the banking sector was financing the
government. Recall that due to the instability of the time, the most common
maturity of deposits was a week. Thus, the liabilities of the central bank
represented very short term maturity debt. At the verge of a stabilization
plan, this ”maturity overhang” can be understood using the model described
above. The Bonex plan was a swap of maturities. It mandatory changed
the deposits of the private sector by ten year maturity dollar denominated
bonds10 . The model above suggest that this may have been a wise way of
reducing the probability of having the bad equilibrium realized.
A final word regarding the Bonex plan. The swap involved both maturi-
ties and denomination. In Calvo (1989), an alternative multiple equilibrium
model is developed that may shed some light into the issue. Assume that
there is a government that launches a stabilization plan and fixes the nominal
exchange rate. For simplicity, assume that the foreign interest rate is zero,
so if expected devaluation is zero, the domestic interest rate is zero. This
government will modify fiscal policy to generate primary fiscal surpluses, but
there is some uncertainty involved. Thus, the surplus will be a real number

 ∈ [ ]

where

0

Thus, with positive probability there will be deficit. Given the stock of
government debt,   the financial needs for the government will therefore
be
10
It is interesting to note that the deposits were swaped by Bonex. There were several
series of Bonex circulating in the economy and these were the bonds that the government
had never defaulted in the past.

16
   +  ∈ [ +     +   ]

Assume also, following the model discussed above, that there is a maximum
 that the market is willing to lend to this government in a given period, such
that if the financial needs in a given period are larger than that maximum,
the government will have to use the international reserves, a balance of crisis
will occur and then the government will devalue.
If the maximum  is larger than  then there is an equilibrium with
 = 0 and no devaluation. In fact, if expected devaluation is zero, then the
probability that the financial needs are higher than the maximum are zero,
thus the probability of a devaluation are zero. On the other hand, is the
expected devaluation is positive, then the nominal interest rate is positive
and, if  is not large enough, the probability that the financial needs exceed
the maximum are positive. This convalidates the negative expectations of the
private sector. Therefore, both features of the swap involved in the Bonex
plan, the maturity and denomination swaps may have been key ingredients
in the stabilization achieved during the eighties.

3.4 Enforcement problems

In this subsection we want to consider theoretical developments that address
the issue of willingness to pay. This feature is crucial, since most of gov-
ernment debt does not have collateral. In the absence of commitment, the
government must find optimal to repay the debt every period. The most
common assumption of the literature11 is that after defaulting, the agent
involved does not have access to capital markets. Thus, every period, the
borrower has to decide either to pay the debt and continue to participate
in the market, or defaulting and loose access to the market. The results do
depend on particular assumptions regarding the degree of commitment of
the lenders and the alternative options available to the borrower. However,
it is possible to construct examples, where an agent that enters the credit
market (Argentina opened the economy to the capital markets in the late
seventies, closed it back and reopened on the early seventies) will be credit
constrained for a while, in the sense that there will be limits to how much can
11
Some of the work in this area inclides Bulow and Rogoff (1989), Marcet and Marimon
(1992) and Albuquerque and Hopenhayn (1997).

17
borrow every period, as a function of the previous record and the realization
of shocks. It is also the case that after a finite number of periods, the credit
constraint stops being binding. These models are interesting, because they
provide examples where the change in the debt is important, not only the
total figure. It also explains why countries with similar income per capita
or other economic variables may have different credit constraints, the reason
being that the accumulated ”reputation” is different. In these models, agents
build reputation over time, so the date in which a country enters the inter-
national capital market does affect the amounts it can borrow. Furthermore,
these models provide a rational for the distinction between ”emerging” and
”developed” markets
Variations on these models consider the case in which the lender cannot
monitor what the country does with the money, and this is relevant since
it affects the ability to pay back in the future. In this case, it may also be
optimal to have the borrower credit constraint for a while.
In these set ups, it is interesting to reconsider the liberalization of capital
markets and financial systems. The experience shows that liberalizing the
financial sector substantially increase the contingent debt, and if the shock
in which the government has to bail out realizes, then the need for debt goes
discontinuously high, and this may not be consistent with the credit con-
straints of the problem. The discussion suggests that a good part of the debt
crisis may be explained by the fact that there was big crack of financial sec-
tors and a substantial increase in governments debt, because the contingent
event realized. Thus, the combination of an ”emerging” government together
with a liberalization of capital flows may be an explosive combination, be-
cause the emerging government will find itself limited on the amount of credit
that can get in the market. The emerging nature of the government implies
that he will be credit constrained for a while. On the other hand, financial
liberalization increases substantially the contingent debt. There seems to be
a tension between opening the country to foreign capital and early financial
liberalization12 .
This literature is still in progress and many of the implications are not
fully understood yet. For instance, the incentives to bail out private debt and
the potential externalities that default by some agents in the country affect
the credit rating of other members in the country have not been analyzed yet
in the context of these models. Further theoretical developments along this
12
For an early and sharp discussion, see Diaz-Alejandro (1985).

18
line will potentially shed additional light into the role capital controls may
play in the early stages of integration of economies to world capital markets.
So far, it is way too early to draw conclusions.
But the discussion somehow rationalizes the use of the ”Calvo ratio”13 ,
defined as 2 over Central Bank Reserves. The reason to use financial sector
liabilities over Central Bank foreign assets is because the liabilities of the
banking sector are contingent liabilities of the Central Bank. We should
stress that this is a reasonable interpretation even if there is no explicit
deposit insurance. World banking history is full of examples in which Central
Banks bailed-out liabilities of the banks, the rationale being the popular ”too
big to fail doctrine”. In fact, one interpretation of the Mexican 1995 crisis
is that the Central Bank bailed-out the bad loans of private banks. This is
the central message of Diaz-Alejandro (1983), further developed by Velasco
(1989). It is also the explanation of the Asian crisis studied in Burnside,
Eichenbaum and Rebelo (1998).
Figure 8 shows the Calvo ratio for Argentina during the period considered.
Figure 9 depicts both the numerator and the denominator. Figure 8 is very
clear. The financial liberalization of the late seventies was accompanied by
a huge increased in the Calvo ratio. Figure 9 shows that the behavior of
the ratio is explained by an astonishing increased in the liabilities of the
financial sector, which is followed by the reserves of the Central Bank the
first two years of the reform, but changes the behavior at the beginning of
1980, one year before the devaluations. On the other hand, note that the
expansion of deposits is similar during the nineties, although the reserves of
the Central Bank follows so the ratio does not exhibit an upward trend during
the period. But the 2001 crisis, started with a massive bank run that lasted
several months, a freeze of deposits and the issuing of bonds to partly bail
out the Banks makes clear that what matters is the size of the potential bail
out. Thus, it appears that a better measure of the financial exposure of the
central banks is the difference between the financial liabilities of the financial
system and the international reserves. Figure 10 shows the evolution of the
financial exposure as a fraction of GDP. By year 2000, the financial exposure
amounted to 20% of GDP. Notice that this value is similar to the financial
exposure in the years prior to the 1982 financial crisis.
13
Guillermo Calvo was, according to our knowledge, the first one to use this index as a
”warning sign”.

19
References
[1] Bekerman, Marta. ”El impacto fiscal del pago de la deuda externa. La
experiencia Argentina. Desarrollo Económico,(1990).

[2] Boletín Estadístico del Banco Central de la República Argentina. (1970)-

(1997).

[3] Boletín Fiscal del Ministerio de Economía y Obras y Servicios Públicos,

(1993)-(1997).

[4] Calvo, G. y P. Guidotti. ”

[5] Calvo, G. y P. Guidotti ”

[6] FIEL, ”El gasto público en Argentina, 1960-1988”. (1991)

[7] Guidotti, P. ”Debt, Monetary and Banking Policy in Emerging Mar-

kets: Reflections from the Tequila Effect”, Working Paper #28, Center
for International Economics, Department of Economics, University of
Maryland at College Park, (1996).

[8] Hall, George and Thomas Sargent (2010), “Interest Rate Risk and Other
Determinants of Post-WWII U.S. Government debt/GDP Dynamics”,
NBER Working Paper 15702.

[9] Indicadores de Coyuntura. FIEL. (1970)-(1997).

[10] Dubey, P., J. Geanakoplos y M. Shubik. ”Default and Efficiency in a

General Equilibrium Model with Incomplete Markets”, Mimeo, Cowles
Foundation,1995.

[11] Lucas, R. y N. Stokey. ”Optimal Fiscal and Monetary Policy in an Econ-

omy without Capital”, Journal of Monetary Economics, 1983.

[12] Rodriguez, C. ”The macroeconomic effects of public sector déficits: Ar-

gentina”. Documentos de Trabajo #76, CEMA, (1991).

[13] Rodriguez, C. ”La Deuda Externa Argentina”, Económica, (1986)

[14] Santos, T. ”Financial Innovations with Endogenous Risk”, Mimeo, Uni-

versity of Chicago, 1997.

20
[15] Sargent, T. ”Rational Expectations and Inflation” (1983)

[16] Schenone, O. ”El comportamiento del Sector Público en Argentina”,

Documento de Trabajo #60, CEMA, (1987).

21
 FIGURE 1
Total Public Debt in 1996 US Dollars

200000

180000

160000

140000

120000
Millons Dollars

100000

80000

60000

40000

20000

0
1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 FIGURE 2.a: Total Public Debt as % GDP

180.0%

160.0%

140.0%

120.0%

100.0%
% of GDP

80.0%

60.0%

40.0%

20.0%

0.0%
1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987

Actual
1988
1989
1990
1991
% GDP

1992
1993
1994
1995

Fixed Real Exchange Rate

1996
1997
1998
1999
2000
2001
2002
2003
2004
Figure 2.b: Simulated Total Public Debt, Fixing the Real Exchange Rate

2005
2006
2007
2008
2009
 0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
Figure 2.c: Real Exchange Rate

1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
 FIGURE 3
Ratio Peso Denominated Debt/ Foreign Currency Denominated Debt

0.5

0.45

0.4

0.35

0.3

0.25

0.2

0.15

0.1

0.05

0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 FIGURE 4
Ratio Nominal Non Indexed Debt/ Any Kind of Indexed Debt

0.25

0.2

0.15

0.1

0.05

0
1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
 Figure 5: Maturity Structure of Government Debt

0.70

0.60

0.50

0.40 1978
%

1982
1997
2000
0.30

0.20

0.10

-
1 year 2 years 3 years 4 years >= 5 years
 FIGURE 6
Central Bank Liabilities as a fraction of Liabilities of Financial Sector

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0
 Figure 7.a: Simulated vs. Actual Debt as a Fraction of GDP

1.8

1.6

1.4

1.2

0.8

0.6

0.4

0.2

Simulated Actual Actual ex non‐performing

 FIGURE 7b
Deficit and Inflation Rate for Argentina

14 450%

12 400%

350%
10

300%
8

250%
6

200%

4
150%

2
100%

0
50%

-2 0%

-4 -50%

Deficit Inflation Rate

 Figure 7.c: Public Sector Deficit of Argentina and Spain

14%

12%

10%

8%

6%

4%

2%

0%

-2%

-4%

Argentine Deficit Spanish Deficit

 Figure 8: Calvo Ratio, 1970‐2002
9

0
 Figure 9: Components of the Calvo Ratio, 1970‐2002
90000

80000

70000

60000

50000

40000

30000

20000

10000

International Reserves Liabilities of the Financial Sector

 Figure 10: Financial Exposure as a Fraction of GDP, 1970‐2002
0.25

0.2

0.15

0.1

0.05