Working Paper: NBER ID: w31296
Authors: Tomas E. Caravello; Pedro Martinez-Bruera; Ivan Werning
Abstract: This study explores the consequences of dollarizing an economy with an initial dollar shortage. We show that the resulting transitional dynamics are tantamount to that of a “sudden stop”: consumption of tradable goods fall, the real exchange rate depreciates abruptly by a discrete drop in domestic prices and wages followed by a gradual appreciation from positive inflation. With nominal rigidities the economy first falls into a recession. This is true even if all prices and wages are allowed to adjust flexibly on impact. The subsequent recovery in activity always “overshoots” the steady state: the non-tradable sector transitions from the initial recession to a boom, then asymptotes to its steady state.
Keywords: No keywords provided
JEL Codes: E10; F30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dollarization (F31) | recession (E32) |
| recession (E32) | recovery (P21) |
| dollarization (F31) | consumption of tradable goods declines (E20) |
| dollarization (F31) | real exchange rate depreciates (F31) |
| recovery (P21) | overshoot of activity towards steady state (E32) |
| initial dollar shortage (F31) | nontrivial transition (P39) |