At the dawn of the XXI century, the drastic lowering of barriers to foreign trade and financial transactions, coupled with the volatility of international capital markets, seem to be propelling the world towards the elimination of monetary divisions. Indeed, a number of regional experts and business leaders -in export oriented sectors-argue that Latin America should abandon its diversity of local monies and adopt the United States dollar as its common currency. In brief, they consider that such formal dollarization is not only unavoidable for Latin America given the increasing globalization of production and finance, but also a necessary step to promote the region's dynamic insertion into the world economy. In their view, this monetary reform, by eliminating all uncertainty regarding nominal exchange rate variations, would produce enormous benefits for the region: greater price stability, reduced transaction costs in foreign trade, lower inflation and interest rates and thus healthier banking systems and higher levels of economic activity. However, notwithstanding its potential benefits, the surrendering of monetary sovereignty entails important costs and risks that should not be overlooked.
As its chairman, Alan Greenspan, has said, the Federal Reserve takes only into account the interests of the United States economy. It presents evidence on the relative size of dollarization, Dollarization in latin america allocation Hot uncensored videos foreign currency deposits, and the behavior of money velocity. However, by passing on the monetary issue and due to gaps in production, labor mobility and trade exchange increase inequality. Google Scholar. Such effects, if persistent, may eventually plunge Latin American economies Dollarization in latin america again into a long-term decline and acute levels of unemployment and under-employment. Modest Benefits, Large Costs The Ecuadoran government anticipated that full dollarization would lower borrowing costs by eliminating foreign exchange risks no local currency to depreciate. Skip to main content. Various economists analyze the positive and negative implications of the radical measure; of course, both benefits and difficulties do not have the same weight in the balance. By no coincidence, average growth fell by half. What is dollarization?
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At the moment, three Latin American countries, all of which have signed on with the U.
- At the moment, three Latin American countries, all of which have signed on with the U.
- Currency substitution or dollarization is the use of a foreign currency in parallel to or instead of the domestic currency.
- At the dawn of the XXI century, the drastic lowering of barriers to foreign trade and financial transactions, coupled with the volatility of international capital markets, seem to be propelling the world towards the elimination of monetary divisions.
- The Latin American region has been the subject of much conversation recently as financial crises spread across the globe.
Miguel A Savastano. This paper examines the pattern of dollarization in Latin America, focusing on the experience of five countries Argentina, Bolivia, Mexico, Peru and Uruguay during It presents evidence on the relative size of dollarization, the allocation of foreign currency deposits, and the behavior of money velocity. The discussion stresses the role of institutional factors, macroeconomic conditions, and the dynamics of money demand In shaping the dollarization process; it also highlights the shortcomings of indicators frequently employed to analyze the phenomenon.
The paper provides a brief critical assessment of the empirical literature on dollarization, and identifies areas where further research seems warranted. Argentina Bolivia Mexico Peru Uruguay. Please address any questions about this title to publications imf. Flagship Publications Other Publications. IMF reports and publications by country Regional Offices. Login or Register Information of interest.
Working Papers describe research in progress by the author s and are published to elicit comments and to further debate.
The pattern of the currency substitution process also varies across countries with different foreign exchange and capital controls. So foreign governments that may be considering full dollarization must do so with the understanding that U. By dollarizing, a country adopts U. Key monetary variables like money supply, credit, and nominal interest rates would then be decided -implicitly or explicitly-by the United States Federal Reserve. Floating floating and free floating.
Dollarization in latin america. Dollarization Declines in Latin America
Such effects, if persistent, may eventually plunge Latin American economies once again into a long-term decline and acute levels of unemployment and under-employment. No developing economy-irrespective of its monetary or exchange rate policies- is immune to the impact of abrupt changes in the global economy that may drastically alter the demand for its main exports, its foreign investment, or even its access to international financial markets.
Consequently, however credible and convenient Latin America's dollarization may seem, it does not guarantee that the region will never again suffer external shocks that mandate macroeconomic adjustment programs.
Such occasions would be a severe test of the viability and adequacy of dollarization in the region. Countries with formal dollarization may never modify their nominal exchange rate, so any adverse external shock in the world economy would have to be accommodated by cuts in the nominal level of its domestic wages and prices. However, the widespread dynamics of monopolistic competition in Latin America and the rigidities in many of its labor markets-deeply rooted in the region's tradition of high inflation- make it difficult to implement major cuts in nominal wages without risking overall political and social stability.
And, unless radical changes in the region's labor and production are implemented, dollarization would likely elevate the social costs of macroeconomic adjustment relative to those in economies not fully dollarized, that still have the option of flexible exchange rate policies. These social costs may be particularly high because Latin America lacks typical compensatory mechanisms to reduce the impact of contractionary shocks by channeling resources to regions affected by adverse circumstances.
Indeed, welfare and unemployment benefits are largely absent in the region. The core of the region's social security system barely protects a minority of workers, those employed in the modern sector of the economy.
If Latin America should adopt the US dollar as its unique and official currency, it would cancel out all possibilities of an independent monetary policy.
Key monetary variables like money supply, credit, and nominal interest rates would then be decided -implicitly or explicitly-by the United States Federal Reserve. There is no guarantee whatsoever that, in such situation, the Fed's decisions will be favorable to Latin America's economic development.
As its chairman, Alan Greenspan, has said, the Federal Reserve takes only into account the interests of the United States economy. In addition, the Deputy Secretary for the US Treasury recently stated that any country contemplating the use of the American dollar as its formal currency should first consult the relevant American economic officers and in any case be aware of its potential consequences, favorable or not.
The loss of autonomous monetary policy would, in particular, imply that any Latin American economy embarked in dollarization would be unable to provide financial support for its domestic banking sector even in cases of severe crisis such as Mexico's. Thus, under full dollarization, such financial institutions would likely have to cease their operations. Is it economically sound to let such banks go broke, instead of temporarily providing extraordinary financial resources to restructure them?
This is a decision to be carefully weighed by national governments and should not be a mere consequence of the implementation of a formal dollarization of the economy. Given the above mentioned limitations and risks, dollarization may easily end up being a costly and failed experiment in Latin America's quest to guarantee price stabilization. To achieve price stability in the region may prove to be an elusive goal. But in its pursuit, policy makers should take into account the potential risks and costs of such policies in terms of the fulfillment of other relevant economic and social objectives.
The elimination of the currency crisis risk due to full currency substitution leads to a reduction of country risk premiums and then to lower interest rates. However, there is a positive association between currency substitution and interest rates in a dual-currency economy.
Official currency substitution helps to promote fiscal and monetary discipline and thus greater macroeconomic stability and lower inflation rates, to lower real exchange rate volatility, and possibly to deepen the financial system. Adopting a strong foreign currency as legal tender will help to "eliminate the inflation-bias problem of discretionary monetary policy".
Currency substitution cannot eliminate the risk of an external crisis but provides steadier markets as a result of eliminating fluctuations in exchange rates.
On the other hand, currency substitution leads to the loss of seigniorage revenue, the loss of monetary policy autonomy, and the loss of the exchange rate instruments. Seigniorage revenues are the profits generated when monetary authorities issue currency. When adopting a foreign currency as legal tender , a monetary authority needs to withdraw the domestic currency and give up future seigniorage revenue.
The country loses the rights to its autonomous monetary and exchange rate policies, even in times of financial emergency. This cost depends adversely on the correlation between the business cycle of the client country the economy with currency substitution and the business cycle of the anchor country. In an economy with full currency substitution, monetary authorities cannot act as lender of last resort to commercial banks by printing money.
The alternatives to lending to the bank system may include taxation and issuing government debt. This cost depends on the initial level of unofficial currency substitution before moving to a full currency substituted economy. This relation is negative because in a heavily currency substituted economy, the central bank already fears difficulties in providing liquidity assurance to the banking system.
Commercial banks in countries where saving accounts and loans in foreign currency are allowed may face two types of risks:. However, currency substitution eliminates the probability of a currency crisis that negatively affects the banking system through the balance sheet channel.
High and unanticipated inflation rates decrease the demand for domestic money and raise the demand for alternative assets, including foreign currency and assets dominated by foreign currency.
This phenomenon is called the "flight from domestic money". At the beginning of this process, the store-of-value function of the domestic currency is replaced by the foreign currency. Then, the unit-of-account function of the domestic currency is displaced when many prices are quoted in a foreign currency.
A prolonged period of high inflation will induce the domestic currency to lose its function as medium of exchange when the public carries out many transactions in foreign currency. Ize and Levy-Yeyati examine the determinants of deposit and credit currency substitution, concluding that currency substitution is driven by the volatility of inflation and the real exchange rate.
Currency substitution increases with inflation volatility and decreases with the volatility of the real exchange rate. The flight from domestic money depends on a country's institutional factors. The first factor is the level of development of the domestic financial market.
An economy with a well-developed financial market can offer a set of alternative financial instruments denominated in domestic currency, reducing the role of foreign currency as an inflation hedge. The pattern of the currency substitution process also varies across countries with different foreign exchange and capital controls. In a country with strict foreign exchange regulations, the demand for foreign currency will be satisfied in the holding of foreign currency assets abroad and outside the domestic banking system.
This demand often puts pressure on the parallel market of foreign currency and on the country's international reserves. However, the effect of this regulation on the pattern of currency substitution depends on the public's expectations of macroeconomic stability and the sustainability of the foreign exchange regime.
From Wikipedia, the free encyclopedia. Redirected from Dollarization. Use of a foreign currency in parallel to or instead of a domestic currency. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. United States dollar users, including the United States.
Currencies pegged to the United States dollar. Euro users, including the Eurozone. Currencies pegged to the euro. Australian dollar users, including Australia.
Indian rupee users and pegs, including India. New Zealand dollar users, including New Zealand. Pound sterling users and pegs, including the United Kingdom. Russian ruble users, including Russia and other territories. Special drawing rights or other currency basket pegs. Three cases of a country using or pegging the currency of a neighbor. Floating floating and free floating. Soft pegs conventional peg , stabilized arrangement , crawling peg , crawl-like arrangement , pegged exchange rate within horizontal bands.
Hard pegs no separate legal tender , currency board. Residual other managed arrangement. Main article: Bretton Woods system. Main article: International status and usage of the euro. Further information: Common Monetary Area. Main article: International use of the US dollar. Feige September
Dollarization in Latin America : Recent Evidence and Some Policy Issues
User Account. IMF eLibrary. Advanced search Help. Kitts and Nevis St. Lucia St. Public Health Health Policy. Nordic Council of Ministers. Print Cite Citation Alert off. Get eTOC Alert. Table of contents Table of contents Close section Volume Get Code Buy. It presents evidence on the relative size of dollarization, the allocation of foreign currency deposits, and the behavior of money velocity. The discussion stresses the role of institutional factors, macroeconomic conditions, and the dynamics of money demand In shaping the dollarization process; it also highlights the shortcomings of indicators frequently employed to analyze the phenomenon.
The paper provides a brief critical assessment of the empirical literature on dollarization, and identifies areas where further research seems warranted. Show Summary Details. International Monetary Fund. Powered by PubFactory. Sign in to annotate. Delete Cancel Save. Cancel Save.