Working Paper: CEPR ID: DP2901
Authors: Douglas M. Gale; Xavier Vives
Abstract: Central bank policy suffers from time-inconsistency when facing a banking crisis: A bailout is optimal ex post but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is preferable when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. A very severe moral hazard problem could make dollarization undesirable, however. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR.
Keywords: banking crisis; IMF; lender of last resort; liquidity; moral hazard
JEL Codes: E58; F30; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dollarization (F31) | improved monitoring efforts (E01) |
| improved monitoring efforts (E01) | better project performance (O22) |
| dollarization (F31) | reduced moral hazard (G52) |
| dollarization (F31) | excessive liquidation of projects (G33) |
| dollarization (F31) | banking stability (F65) |