This paper discusses the causes and problems associated with dollarization. Based on the results, it addresses the questions of how high dollarization rates can be evaluated and, in particular, whether it is advisable to opt for full dollarization (FD) or to what extent policymakers should rather aim for de-dollarization. As an introduction to the discussion, Chapter 2 will give a short illustration of the theoretical concepts of dollarization. Chapter 3 will then explain the causes of dollarization. The subsequent description of the advantages of FD in Chapter 4, which can also be cited as a reason for high rates of dollarization,3 leads directly to the problems associated with dollarization in Chapter 5. These problems arise – unless otherwise stated – both from high dollarization rates and from FD. The research up to Chapter 5 concentrates on a more theoretical level. The discussion on how to evaluate the causes and problems in Chapter 6 tries to link theoretical concepts with more general empirical analyses. Chapter 7 provides a brief conclusion of the most important findings and concludes with recommendations for future research.
“Dollarization has evolved as one of the noteworthy features of globalization during the last two decades.” Although Mr. Yilmaz, the then Governor of the Central Bank of the Republic of Turkey, said this sentence at a conference on dollarization in December 2006, it remains more relevant than ever. Due to the increasing integration of the international financial system, the lifting of restrictions on capital mobility and the growing volume of trade, the debate on dollarization met with a growing interest in the 1990s. Nonetheless, today's economic journals are still filled with new publications on dollarization.
Table of Contents
1 Introduction
2 Theoretical concepts and characteristics
3 Causes of dollarization
4 Benefits of full dollarization
5 Problems associated with dollarization
6 Discussion on how to evaluate the causes and problems
7 Conclusion
Objectives & Core Themes
This paper examines the underlying drivers of dollarization and investigates the associated economic challenges and potential risks for national economies. It addresses whether countries should pursue full dollarization or focus on strategies for de-dollarization to regain monetary policy autonomy.
- Theoretical foundations and classification of dollarization phenomena.
- Primary causes, including macroeconomic instability and market imperfections.
- Economic advantages of full dollarization for emerging markets.
- Disadvantages, such as the loss of independent monetary policy and lender-of-last-resort capabilities.
- Evaluation of policy implications for achieving financial and monetary stability.
Excerpt from the Book
3 Causes of dollarization
Informal dollarization (ID) can be described as a rational response to hedge a variety of risks, whenever economic agents have low confidence in the domestic currency. Since payments across borders are predominantly carried out in internationally accepted currencies, foreign currency inflows leading to ID are an almost unavoidable result especially for small economies being largely open to trade or exports. And while parts of the holdings of foreign currency can constitute the convenience of having transactions balances in the currency of payments, it cannot explain ID on the observed scales.
Main factors arise from macroeconomic instability resulting from domestic inflation or real exchange rate (ER) movements. In the context of inflation uncertainty ID is technically explained through higher volatility of inflation, relative to that of the real ER. The inability to predict large fluctuations of the ER induces lenders to provide loans in foreign currencies and therefore intensifies dollarization. Another main factor, a high and fragile public debt structure along with high budget deficits, often results in the phenomenon “original sin”.
Chapter Summaries
1 Introduction: Provides an overview of the increasing relevance of dollarization in the context of globalization and outlines the structure of the paper.
2 Theoretical concepts and characteristics: Defines dollarization and full dollarization, distinguishing between asset and liability dollarization.
3 Causes of dollarization: Analyzes the rational motives behind informal dollarization, highlighting macroeconomic instability and market imperfections.
4 Benefits of full dollarization: Discusses how full dollarization can restore macroeconomic stability and enhance credibility in central banking.
5 Problems associated with dollarization: Explores the loss of effective monetary policy and the lender-of-last-resort function as significant drawbacks.
6 Discussion on how to evaluate the causes and problems: Connects theoretical concepts with empirical considerations and evaluates arguments for and against dollarization.
7 Conclusion: Summarizes the key findings and highlights the necessity for further research on policy solutions for de-dollarization.
Keywords
Dollarization, Full Dollarization, Informal Dollarization, Macroeconomic Instability, Monetary Policy, Exchange Rate, Financial Fragility, Seigniorage, Original Sin, Market Imperfections, Developing Countries, Emerging Markets, Inflation, Financial Development, De-dollarization.
Frequently Asked Questions
What is the primary focus of this paper?
The paper explores the drivers of dollarization, its economic consequences, and the debate surrounding the adoption of foreign currencies in developing and emerging economies.
What are the central themes discussed?
The core themes include the definitions of currency substitution, the causes of informal dollarization, the potential benefits and significant risks of full dollarization, and the challenges of regaining monetary autonomy.
What is the central research question?
It investigates how dollarization rates are evaluated and whether full dollarization serves as a viable strategy or if nations should prioritize de-dollarization.
Which scientific methods are employed?
The paper conducts a qualitative analysis based on existing economic literature, theoretical frameworks, and empirical observations of dollarized economies.
What is the focus of the main body?
The main body details the mechanics of dollarization, identifies its drivers such as inflation and public debt, and critically assesses the trade-offs between stability and policy independence.
What characterizes this paper's key terminology?
The research emphasizes concepts like "original sin," seigniorage, and the "inconsistent quartet," which are essential for understanding the constraints of dollarized monetary regimes.
Why is "original sin" a critical concept in this study?
It describes the government's inability to borrow in its own currency due to time-inconsistency issues, forcing a reliance on foreign currency debt and leading to financial fragility.
How does the paper address the loss of the "lender of last resort" function?
It explains that in fully dollarized economies, authorities lack the ability to inject unlimited liquidity, which increases vulnerability to banking crises and deposit runs.
- Arbeit zitieren
- Fabio Botta (Autor:in), 2020, Causes and Problems of Dollarization, München, GRIN Verlag, https://www.grin.com/document/703214
