Prudential responses to de facto dollarization pdf

Financial dollarization is a key factor behind systemic financial fragility in latin. Impulse responses of inflation to exchange rate changes. Macroprudential policy, monetary policy and the limited costs of separation. Second, dollarization can also establish a firm basis for a sounder financial sector. Several countries have already officially adopted the us dollar as legal tender. Capital flow reversals,the exchange rate debate,and. In fact, the allocation of seignorage can be part of com pensation schemes between anchors and clients.

We nd the most convincing case for prudential activism is associated with moral hazard dollarization. Dollarization and financial integration jonathan heathcote. To learn about our use of cookies and how you can manage your cookie settings, please see our cookie policy. Some small economies, for whom it is impractical to.

Some analysts argue that financially open economies are best served by more flexible regimes, while others argue in favor of extreme exchange rate regimes that have a strong. It also means financial integration with the united states, which will force domestic financial institutions to improve their efficiency and the quality of their services. Introduction in the last few years, the idea of dollarization has surged to the forefront of monetary policy alternatives for latin american countries. International currencies and national monetary policies. How the pa resolves this issue will have longterm ramifications on the ability of future governments to manage macroeconomic issues such as inflation and deal with external shocks to the economy. The sceptics are right because they can relate with the benefits of dollarization and are yet to know what dedollarization will bring them. Monetary and financial systems department, we develop a theoretical framework that encompasses four distinct motives for dollarization and discuss appropriate policy responses to help contain dollarization and its attendant risks. Hyperinflation in 1980s pushed deposit dollarization above 60%. Stabilization policy and the costs of dollarization. Official dollarization and the banking system in ecuador and. Dollarization in emergingmarket economies and its policy. For example, the choice of a one to one parity in the case of.

With the persistent instability of international financial markets, emerging economies are exploring new ways to reduce exposure to capital flow volatility. Policy abandoned in 1990 leading to re dollarization around 80%. Use the free adobe acrobat reader to view this pdf file. We develop a theoretical approach that encompasses four distinct motives for dollarization and discuss appropriate policy responses. Probable advantages include an increase in investment flows from the u. As for government intervention, prudential regulation should aim at limiting the possibility. A common interpretation of the high and volatile in. The zimbabwean government broke a world record with an unmanageable inflation that opens the way for the dollarization of the country. Part of the logic for our story is that it must be costly to switch to a. And the process is not helping matters at all, it seems. As a currency board, a bicurrency system allows central banks to retain seignorage benefits. It is fast turning into a damp squib given the publics level of appreciation of the benefits there are.

Currency substitution or dollarization is the use of a foreign currency in parallel to or instead of the domestic currency currency substitution can be full or partial. Effect of official dollarization on a small open economy. Jonathan heathcote how does a countrys choice of exchange rate regime impact its ability to borrow from abroad. Capital controls have been widely discussed, but dollarization may offer a longerterm and more marketfriendly solution. Financial dollarization shows a moderate response to prudential measures in. A new test is proposed and implemented to investigate endogeneity of money. Another cost of dollarization is the loss of sei gnorage for the client country. Persistence of dollarization after price stabilization. It also means financial integration with the united states, which will force domestic financial institutions to.

Finally, money supply is endogenous after dollarization and exogenous before dollarization. Costs and benefits of dollarization myriam quispeagnoli. However, this loss is not a social waste, but rather a redistribution between the countries. Most of the empirical literature analyzing financial dollarization or euroization defined as the holding by residents of a share of their assets andor liabilities denominated in foreign currency has concentrated on the determinants of either credit or deposit dollarization, 1.

We present a model that encompasses three distinct motives for dollarization price volatility, credit risk, and moral hazard and discuss when riskbased prudential policy responses are called for and the form they should take. Policy abandoned in 1990 leading to redollarization around 80%. Page 3 buying motivation page 3 dollarization and selling pages 4, 5 reduction to the absurd page 4 dollarization and marketing page 6 dollarization techniques pages 7, 8 three steps in one meeting page 7 customer buyin is a must page 8 the dollarization doctrine page 8 by jeffrey j. Use the free adobe acrobat reader to view this pdf. Dollarization and financial integration federal reserve. Hoping youll forgive the clumsy word, ill then make some remarks about the difference in the measurability of the performance of the two policies. Dollarization does bring lower and less volatile in. Official dollarization and the banking system in ecuador. We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. Karam abstract while being an important relative price in the economy, the exchange rate itself is just one technical element in a broader monetary and exchange rate. Forced dedollarization in 1985 caused capital flight and financial disintermediation. Google scholar revised version published in the journal of policy reform, vol. This paper addresses the dollarization debate from this perspective, with the goal of setting the stage for a more detailed and focused discussion of whether dedollarization should be a policy. Financial dollarization in latin america springerlink.

We present a model that encompasses three distinct motives for dollarization price volatility, credit risk, and moral hazard and discuss when. The economic benefits and costs of official dollarization for argentina are analyzed. The working paper series seeks to disseminate original research in economics and finance. As a result, we conclude that dollarization improved the macroeconomic performance of ecuador and changed the moneyprice relationship in ecuador. Most of the empirical literature analyzing financial dollarization or euroization defined as the holding by residents of a share of their assets andor liabilities denominated in foreign currency has concentrated on the determinants of either credit or deposit dollarization, 1 but typically not both e.

However, prudential reform will have only a limited impact on dollarization when the main culprits are fear of floating and lack of monetary credibility. Dollarization and financial integration cristina arellano. If so, they may ultimately find dollarization to be irremovable. Moral hazard dollarization provides a clear case for prudential policy activism. In principle, the anchor could return the seignorage to the client. The views expressed in this working paper are those of the authors and do not necessarily represent those of the imf or imf policy. The ones marked may be different from the article in the profile. We argue that the overall policy response must be tailored to the nature of the dollarization the economy is facing. International monetary fund, universidad torcuato di tella. Exports and external fx loans supported high dollarization in 1970s. This cited by count includes citations to the following articles in scholar.