Working Paper: NBER ID: w8838
Authors: Roberto Chang; Andrés Velasco
Abstract: This paper discusses major analytical aspects of dollarization and their practical implications. We develop a simple model to stress that dollarization implies the loss of independent monetary policy and of seigniorage, yet the significance of such losses can only be evaluated in conjunction with assumptions about the policymaking process. If the government is benevolent and has no credibility problems, dollarization causes a fall in welfare, which can be measured by the implied seigniorage loss or using Mundellian optimal currency area criteria. However, outcomes are rather different if credibility is absent and dollarization can serve as a commitment device: the welfare impact of dollarization is ambiguous, and seigniorage measures and Mundellian criteria may be misleading indicators of the true cost of dollarization. We also evaluate other implications of dollarization, such as those related to last resort lending and financial stability.
Keywords: No keywords provided
JEL Codes: E42; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dollarization (F31) | Loss of independent monetary policy (E49) |
| Dollarization (F31) | Loss of seigniorage (H69) |
| Loss of seigniorage (H69) | Negative impact on welfare (I30) |
| If government is benevolent and credible (H11) | Dollarization leads to fall in welfare (D69) |
| Dollarization (in absence of credibility) (E41) | Ambiguous welfare outcomes (D69) |
| Dollarization (F31) | Exacerbation of financial fragility (F65) |
| Exacerbation of financial fragility (F65) | Increased likelihood of financial crises (F65) |
| Policy credibility problems (G22) | Complicated interpretation of seigniorage losses (E49) |