"I am very happy to join Chelsea, the champions of England", said Caballero.
While Caballero will be a backup at his new club, his experience and talent will be crucial to Chelsea as they return to fighting on all four fronts this season.
Blues football chief Michael Emenalo added: "We are very happy to have Willy on board".
He replaces Asmir Begovic, who has left Chelsea for Bournemouth. But under newly appointed manager Pep Guardiola, he could only manage to make 24 starts and a further two substitute appearances for City last season.
The highlight of his time at City was the 2016 League Cup final when his heroics during the decisive penalty shoot-out against Liverpool ensured City secured the trophy. "He knows the Premier League and is tried and tested at the top of the game", he said.
Caballero was the starting goalkeeper for Argentina's Olympic squad that won the gold medal at the 2004 Summer Olympics in Athens.
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