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Chapter 30: Problem 17

The Economist observed, "In Argentina, many loans were taken out in dollars: this had catastrophic consequences for borrowers once the peg collapsed." What does the article mean when it says that Argentina's "peg collapsed"? Why was this collapse catastrophic for borrowers in Argentina who had taken out dollar loans?

Short Answer

Expert verified
A 'peg collapse' refers to the inability to maintain a fixed exchange rate between two currencies. In Argentina's case, the peg collapse meant the devaluation of the Argentine peso against the US dollar. This was catastrophic for borrowers who had taken dollar loans because they were earning in pesos but had to pay back in dollars. When the value of peso decreased, they needed more pesos to buy the same amount of dollars, hence their debt increased substantially.

Step by step solution

01

Understand the 'Peg' in Economics

A 'peg' in economics refers to a policy that links the exchange rate of one currency to another. For Argentina, the 'peg' would refer to the fixed exchange rate where one Argentine peso was equal to one US dollar. This was done to stabilize the Argentine peso and prevent inflation.
02

What is 'Peg Collapse'

A 'peg collapse' refers to a situation where the fixed exchange rate can no longer be maintained. In the case of Argentina, the government could not support the 1:1 peso to dollar ratio leading to the devaluation of the peso.
03

Impact of Peg Collapse on Dollar Loans

Now, to understand why this was catastrophic for the borrowers who had taken out dollar loans: these borrowers have to repay their loans in dollars, but they earn in pesos. When the peg collapsed, the value of peso decreased drastically. So, to buy the same amount of dollars, they now need more pesos. Therefore, the amount they have to pay back in terms of pesos increases, leading to increased debt, making it catastrophic for the borrowers.

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Most popular questions from this chapter

(Related to the Don't Let This Happen to You on page 1061 ) Briefly explain whether you agree with the following statement: "The Federal Reserve is limited in its ability to issue paper currency by the amount of gold the federal government has in Fort Knox. To issue more paper currency, the government first has to buy more gold."

An article in the Toronto Star discussed the Canadian teams that play in the National Hockey League, the National Basketball Association, Major League Baseball, and Major League Soccer. The article noted, "Under their collective agreements players get paid in U.S. dollars. The majority of [team] revenue, however, is in Canadian currency." Are Canadian professional sports teams better off when the Canadian dollar increases in value relative to the U.S. dollar or when it decreases in value? Briefly explain.

The United States and most other countries abandoned the gold standard during the \(1930 \mathrm{~s}\). Why would the 1930 have been a particularly difficult time for countries to remain on the gold standard? (Hint: Think about the macroeconomic events of the \(1930 \mathrm{~s}\) and about the possible problems with carrying out an expansionary monetary policy while remaining on the gold standard.)

An article in the Atlantic referred to a poll of economists that found no support for the United States to readopt the gold standard: It prevents the central bank from fighting recessions by outsourcing monetary policy decisions to how much gold we have -which, in turn, depends on our trade balance and on how much of the shiny rock we can dig up. When we peg the dollar to gold we have to raise interest rates when gold is scarce, regardless of the state of the economy. Why does the writer state that a gold standard would prevent "the central bank from fighting recessions"?

How were exchange rates determined under the gold standard? How did the Bretton Woods system differ from the gold standard?
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