Devaluation Beliefs and Debt Crisis: The Argentinian Case

Throughout the year 2001 the Argentine real GDP fell by 20 percent and the Investment Rate decreased by more than 20 percent of the GDP. The government made several announcements on changes in exchange rate policy in order to assist the recovery of the economy. At same time, the Trade Balance produced a huge surplus and the Argentine External Debt over GDP ratio increased so much that it forced the Argentinian government to default and, afterwards, devalue the peso 40 percent. We explore the relationship between default and the expectations on devaluation. We find that depending on the level of debt and given an expectation of devaluation two types of crises can arise: if the level of debt is low the government devalues but does not default; for a higher level of debt, the government devalues and defaults to cancel the future cost of repaying the debt. We have calibrated our model to match the main features of the Argentine crisis and we show that the External Debt over GDP ratio was in a crisis zone where the government found it optimal to default and to devalue.