Argentina: Cavallo, lope for disaster?

This paper analyses the latest stabilization effort in Argentina, the Cavallo Plan(named after its mentor, Domingo Cavallo). The analytical framework is the tradeable – nontradeable textbook model, also known as the dependent economy model, from the Australiantrade literature. The model is extended to include the effect of real wages on aggregatedemand, and therefore on activity. A Phillips curve description of inflation is also added. Itis shown that, by moving from a floating to a fixed-exchange rate regime, the Argentinianeconomy attained domestic equilibrium, at the cost of balance of payments equilibrium. Thepaper shows that the ensuing trade deficit may lead to a classical run on reserves, forcing thereturn to floating exchange rates. In the process, the economy will go through a completeeconomic cycle, returning to inflation. JEL Classification: E31; F31.