Monetary unions—a superior alternative to full dollarization in the long run☆

Abstract

The paper extends the debate about the exchange rate system that is appropriate in view of the pressures for currency consolidation in open international financial markets to the issue of full dollarization versus (multilateral) monetary union. Unilateral dollarization may not be sustainable politically in the long run because fully dollarized countries may not be willing to keep on paying a seignorage tribute to the United States once they have built a record of internal stability. Even in the short and medium term, fulfillment of the fiscal and regulatory adjustments and reforms required for multilateral monetary union is preferable to embarking on unilateral dollarization without assurance that needed reforms will be supported by the country’s main constituencies.