We may witness another attempt to dollarize an economy. In light of Javier Milei’s electoral victory, we analyze one of his original campaign promises to dollarize Argentina. Although the US dollar is a credible anchor, Argentina does not meet the classic requirements for belonging to the same currency area as the US. Given the lack of international reserves and high monetary liabilities, rapid dollarization would be very difficult today. Fiscal consolidation and discipline, as well as structural flexibility, would be key to successful dollarization. But, as Ecuador’s experience shows, this would be a difficult task.
In the euro area, cyclical economic indicators appear to have bottomed out, suggesting that the worst may be behind us. Indicators still point to negative GDP growth in the fourth quarter and, therefore, a likely recession in the second half of 2023. However, the decline in economic activity appears to be slowing, while companies remain cautiously optimistic about the economic outlook. This could set the stage for slightly stronger private consumption in the coming quarters as real wages rise due to lower inflation and higher nominal wages.
Finally, we analyze the progress of quantitative tightening (QT) in the US. We find that withdrawals from the Fed’s overnight repurchase facility (O/N RRP) absorbed much of the impact of QT on bank reserves in 2023. Interestingly, however, banks have been actively combating the drawdown in bank reserves by increasing their reserves of liquidity and replacing deposit outflows with large and expensive time deposits. The banking system’s high preference for liquidity suggests that the level of optimal bank reserves is unlikely to fall much below current levels. Once the RRP O/N is exhausted in the second half of 2024, the QT will likely have to be discontinued.
By Dr. Karsten Junius, Chief Economist, J. Safra Sarasin
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