The case for starting a new exchange rate after debt settlement: Reexamining alternatives to Argentina’s exchange rate policy in 2001–2002

This research explores the question of which exchange rate regime would bring about better output and price stability, given the initial conditions and the external shocks facing Argentina’s economy in 2001–2002. Our analytical model incorporates a transmission mechanism, the balance‐sheet effects, which formulates the possible interaction between foreign debt and exchange rate policy. We find that a floating exchange rate that depends on external finance outperforms dollarization, after supposing the amount of foreign debt payments is limited. As the relative performance of alternative exchange rate arrangements depends on the foreign debt payments, our empirical results imply that the restructuring of foreign debt should be an integral part of any negotiation concerning the postcrisis exchange rate regime. Our results also show that with the existence of foreign debt, the policy trade‐off implied by the Trilemma becomes much constrained.