BANKING STRUCTURES, MARKET FORCES, AND ECONOMIC FREEDOM: LESSONS FROM ARGENTINA AND MEXICO

The successes or failures of monetary reforms in Latin America have depended on the financial liberalizations that accompanied them and on the peculiarities of attendant financial regulations and provis-ions. The absence of guarantees to make bank depositors whole in a financial crisis, for example, signifies a far different distribution of likely patterns of monetary growth and exchange-rate pressures than a more conciliatory treatment of depositors would have, even if a government is otherwise committed to tight money and a strong currency. More generally, the economic literature on monetary arrangements has shown increased appreciation of the links between official protections for financial institutions in newly liberalized envi-ronments, subsequent banking crises, and exchange-rate volatility (McKinnon and Pill 1996, Kaminsky and Reinhart 1996, Krugman 1998). Of particular concern in this context are how problems of moral hazard metastasize under financial liberalization when government guarantees abridge market discipline. This paper presents evidence of the linkages between market disci-pline, government guarantees, bank performance, and exchange-rate stability in Argentina and Mexico. As will be detailed, Mexico’s encom-passing deposit guarantee program was associated with risky lending behavior beginning during the 1991–92 bank privatizations. The resulting bank crisis offered unresolvable tensions in the goals of monetary policy—preserving the banks versus preserving the exchange rate—and motivated a policy trajectory that had much to do with the subsequent exchange-rate crisis