Argentina's fragile monetary framework risks renewed volatility

Like a modern Houdini, Argentina’s president Javier Milei has escaped serial financial perils, emerging each time with a revised monetary framework. Argentina’s latest monetary scheme, which debuted on January 2, 2026, is designed to patch some of its predecessors’ defects in pursuit of further inflation reductions, more foreign exchange reserves, and renewed economic growth. The scheme could work, especially if backed by continued bilateral and multilateral financial support and a timely return to financing from global capital markets, but it contains new vulnerabilities that make the country’s path to price stability unnecessarily narrow.

Rapid inflation stabilization amid scarce international reserves

Upon entering office in December 2023, Milei hiked interest rates and slashed government outlays, making good on his chainsaw-waving promises to voters. Severe fiscal retrenchment eliminated a national government budget deficit that had been running at about 5 percent of GDP. While loosening a complex web of trade and price controls, Milei carried out an immediate maxi-devaluation of the peso and introduced a crawling peg regime that forced the currency initially to depreciate by 2 percent per month against the US dollar. Depreciation was reduced to 1 percent a month starting in February 2025. The crawling peg provided a powerful nominal anchor to force the inflation rate down: Over the three quarters following Milei’s inauguration, monthly inflation fell from over 20 percent to low single digits, where it has so far remained. “Shock therapy” led to a quick turnaround in 12-month-ahead inflation expectations, with actual year-on-year inflation outcomes dropping below even those optimistic expectations (see figure 1 below).

While the recession in early 2024 had a crushing effect on ordinary Argentines, it pushed the current account balance into surplus, mitigating the government’s foreign exchange needs. In addition, Argentina’s government initially rebuilt reserves further to make up for irresponsible policies by the Peronist government of Milei’s predecessor, Alberto Fernández, who ran the country’s reserves down to very low levels in the lead-up to the presidential election that brought Milei to power.

Over time, however, the peso appreciated in real terms (its nominal depreciation rate was below Argentina's inflation rate), making exports more expensive for foreign buyers and imports cheaper. Big reductions in import taxes lowered import prices further. The current account swung sharply into deficit at the start of 2025, money left the country, and international reserves again plummeted. Argentina’s ability to meet its large foreign debt obligations melted and financial market access prospects dimmed. It was then, in April 2025, that Milei performed his first escape act. Argentina negotiated a 48-month, $20 billion support program with the International Monetary Fund (IMF) and talked the Fund into providing $12 billion up front.

A revised currency framework under pressure

With the IMF program came a revised monetary framework. Milei scrapped most restrictions on resident acquisitions of foreign currency and moved to a more flexible crawling band system for the peso, with an upper band for the peso price of US dollars rising at 1 percent per month and a lower band falling at the same rate (see figure 2). The band allowed room for real peso depreciation—at least until the upper limit was reached—and Argentina promised the IMF that it would use that flexibility to buy dollar reserves, selling them only if the peso hit the band’s top and forced dollar sales to prevent further depreciation.

But the promise was not kept: Argentina missed its reserve targets and remained perilously short on dollars. When Milei’s party was trounced in Buenos Aires provincial elections on September 7, 2025, market participants began to fear the same result in the October 26, 2025 mid-term legislative elections and sold pesos. An electoral defeat would have left Milei with too few deputies in the lower house of the national congress to sustain presidential vetoes, opening the door to Peronist-backed bills inconsistent with fiscal stabilization and deregulation efforts. The peso, which had been gradually depreciating within the band, moved quickly toward its upper limit, forcing heavy dollar sales by the Argentine authorities. The JPMorgan Emerging Market Bond Index (EMBI) spread on Argentine dollar bonds widened to near 1,500 basis points. It looked like Argentina might run out of reserves and devalue or allow the rate to float. That would have blown up Milei’s entire program, risking renewed inflation, and dealt a possibly fatal blow to his electoral chances on October 26.

Yet Milei escaped disaster once more. The US Treasury unexpectedly made $20 billion available to Argentina in the form of a swap facility and in early October 2025 intervened directly in the Buenos Aires foreign exchange market, reportedly spending about $2.5 billion. The peso (barely) stayed within its band, and voters proved unwilling to return to the economic chaos of Peronism: They gave Milei’s party an unexpectedly strong plurality in the 2025 midterm elections. Market confidence returned: Milei had won room to advance his economic program and run on the results in the October 2027 presidential election.

Navigating without an anchor: The new currency framework

Prior to the October 2025 election, the top of the peso’s band had been rising at 1 percent per month while monthly inflation remained at 2 percent per month or higher, implying that the peso’s upper appreciation limit was rising in real terms, with increasingly limited scope for exchange rate flexibility and reserve accumulation. At the start of this year, the government began to expand the exchange rate band, not at 1 percent per month but at the rate of inflation prevailing two months earlier. Thus, over January 2026 the band expanded by 2.5 percent (the November 2025 inflation rate), and for February 2026 the band is set to expand by 2.8 percent (the December 2025 inflation rate).[1] Argentina’s central bank (the Banco Central de la República Argentina, or BCRA) also intends to use the relaxed band to make regular purchases of dollars to replenish its reserves and support external debt repayments. These dollar acquisitions, together with continued support from bilateral and multilateral creditors, as well as efforts to re-access private markets, are imperative if Argentina is to pay its foreign bills over the rest of 2026 and coming years.

The new arrangements no longer build in mechanical and possibly excessive real appreciation of the bands over time, but that flexibility comes with a cost.[2] The earlier exchange rate schemes had provided a “nominal anchor” for monetary policy by imposing an exogenous maximal value of currency depreciation, which discouraged high inflation. The new framework, however, discards that exchange rate anchor. The lagged indexation of the exchange rate to inflation imparts a greater degree of inertia to inflation. Related, because the inflation rate that the economy produces in a month T automatically becomes the maximal depreciation rate in month T+2, the scheme encourages inflation in T: Whatever level the economy produces will entirely (and predictably) be accommodated by currency depreciation in T+2. This could be a dangerous dynamic for Argentina, with its history of high inflation and its extensive dollarization.

While allowing a bigger range for the exchange rate, the new band still does not eliminate the possibility of another currency crisis like the one in the autumn of 2025. Because the peso has remained close to the top of the band, a negative economic shock could bring renewed speculative pressure for a currency devaluation and a renewed need for US Treasury support. The possibility of that support being limited or conditional further weakens the exchange rate’s ability to anchor inflation.

Does the plan have an alternative anchor? Some commentators claim that by balancing the national budget, Milei has eliminated the need for monetary financing of the government deficit and thereby provided an anchor. While balanced public accounts are an immense achievement, the government likely will have to run surpluses going forward to accumulate foreign exchange reserves, and these are most likely to be financed by purchases of dollars with pesos—that is, monetary financing.[3] The result will be inflationary unless Argentines feel sufficiently confident in the economy to convert some of their dollar holdings into peso money balances, something the Milei government continues to promote actively. Confidence could evaporate easily, however, in the face of adverse events.

Another possible nominal anchoring strategy is to control the growth of the money supply. The central bank seems to have this approach in mind, having stated:

As long as observed inflation remains above international inflation, the BCRA will maintain a contractionary monetary bias with respect to its estimate of the base path of money demand.

Money demand in Argentina is volatile, however, the more so because people can switch easily between pesos and dollars; so, an attempt to calibrate money-supply growth to a forecast of future money demand will inherently be a hit-or-miss exercise. Even worse, a higher price level implies a higher demand for peso money balances, even if expected future inflation is somewhat higher at the same time.[4] Under the vague rule quoted above, the central bank could therefore end up accommodating higher inflation to some degree with a higher money supply, while mistakenly believing its policy was providing a firm nominal anchor: The devil will be in the details of how the policy is implemented. Finally, restrictive money supply growth could clash with the government’s need to acquire foreign exchange reserves.

A better strategy

Other countries in Latin America have had success with inflation targeting approaches where the exchange rate floats and a policy interest rate or a nominal monetary aggregate growth rate is adjusted to push inflation toward a target level. Argentina tried this strategy under Mauricio Macri’s presidency, but in a half-hearted manner and without the balanced budget that Milei has achieved. The framework’s calamitous failure in 2018 led to a massive IMF program loan that the country is still repaying; it evidently had a traumatic effect on Argentine policymakers.

Now that his domestic political situation is relatively strong, however, Milei’s chances of success would be greater than Macri’s, and an inflation-targeting approach would provide a clear nominal anchor in the form of the inflation target itself. A good first step would be to announce specific realistic inflation targets or at least narrow ranges for the next two years and then adjust monetary policy to push the economy toward those levels. This is not a trivial enterprise in an economy as dollarized as Argentina’s is, but it promises a more coherent policy strategy than the current one.

In discussing American financial support for Argentina last October, US Treasury Secretary Scott Bessent said that the exchange rate band then in effect “remains fit for purpose.” Evidently not for long, as the old band has now been scrapped. The new setup has positive features—a more flexible real exchange rate as well as a schedule for acquiring foreign exchange reserves. But its weak nominal anchor is a flaw that could prove fatal—and perhaps beyond even Milei’s escape-artist skills.

Notes

1. The current political controversy in Argentina over revising the consumer price index methodology therefore has direct implications for exchange rate policy.

2. The rule would actually allow real depreciation against the dollar over time if US inflation is positive. To maintain a constant real exchange rate, the peso’s nominal depreciation would have to equal Argentine inflation less US inflation; peso depreciation equal to Argentine inflation therefore implies real peso depreciation against the dollar. An appreciation of the US dollar itself could, however, add to the band’s constraints (given trade with Brazil and other non-US partners).

3. In principle a central bank can finance reserve purchases by selling domestic securities on its balance sheet, keeping the size of the balance sheet constant, but this sterilization strategy can raise other difficulties and is unlikely to be a source of significant foreign exchange. The so-called “fiscal theory of the price level” fails as a nominal anchor, both because a major margin of adjustment for the market value of Argentine government debt is through the dollar prices of its dollar bond issuances, and because the continuance of current fiscal policies beyond the current presidential mandate remains uncertain.

4. A simplistic regression of the logarithm of the real monetary base (the monetary base divided by the consumer price index) against the log expected inflation rate in monthly data from January 2022 to December 2025 yields an expected inflation elasticity of real money demand equal to –0.12 (t-statistic of –2.97). This estimate suggests that higher inflation fueled by destabilizing expectations could, on net, raise nominal money demand.