Dollarization in Latin America: Gresham's Law in Reverse?

Abstract

Since the 1970s, a number of high-inflation Latin American countries have experienced persistent dollarization. To interpret some of the stylized facts, a simple model is presented in which dollarization reflects the costs that are involved in switching the currency denomination of transactions. The transaction costs of dollarization define a band for the inflation differential within which there will be no incentive to switch between currencies. Above the upper value of the band, the local currency gradually disappears as the economy becomes fully dollarized; below the lower value, de-dollarization occurs.