Reassessing the feasibility of adopting dollarization in Latin America

León Padilla

doi:10.1108/jefas-08-2020-0282

Abstract

PurposeThis paper analyses the possibility of Latin America's (LA) major economies adopting dollarization, considering that in the last decade macroeconomic instability has once again challenged the ability of certain economies to properly manage their own currency.Design/methodology/approachTo determine the feasibility of adopting the US dollar as official currency, the author uses the framework of optimum currency area (OCA) theory, since, in fact, dollarization is an incomplete monetary union. The author uses a structural vector autoregressive (SVAR) model to identify what type of structural shock — country-specific, regional or global — prevails in LA economies. For this purpose, the US output is used to represent the global output and determine how the shocks of the US influence the output trajectory of each LA nation. The higher the influence of the US product, the lower the costs of adopting the US dollar.FindingsThe results of the variance decomposition show that the influence of the US shocks in the gross domestic product (GDP) trajectory of LA countries has significantly decreased over the last two decades, even in the currently dollarized economies. The estimates for Venezuela and Argentina show that the importance of US shocks in the trajectory of their GDP is low. Therefore, the cost of adopting the US dollar as the official currency would be high.Originality/valueIn view of hyperinflation and macroeconomic imbalances in certain LA nations, the dollarization debate has resurfaced in recent years. However, the literature that empirically evaluates the feasibility of adopting dollarization as a monetary system under current economic conditions is limited.

Highlights

It is well known that currency substitution — or partial dollarization — is a recurring problem in Latin America (LA) nations and that the greater the degree of a shift away from domestic to foreign currencies, the more sensitive a country’s monetary aggregates are to sudden movements in exchange rates, productivity and interest rates (Prock et al, 2003)
The results indicate that all variables are non-stationary at a level
Following the cointegration tests based on the method proposed by (Engle et al, 1987), we determine that the logarithm of global, regional and local outputs are non-cointegrated

Summary

Introduction

It is well known that currency substitution — or partial dollarization — is a recurring problem in Latin America (LA) nations and that the greater the degree of a shift away from domestic to foreign currencies, the more sensitive a country’s monetary aggregates are to sudden movements in exchange rates, productivity and interest rates (Prock et al, 2003). Currency substitution is a form of dollarization and can even be the door to giving up the national currency (Calvo and Vegh, 1992). In this sense, official dollarization is an extreme — fixed-exchange rate — monetary regime, in which the dollarized country formally renounces the issuance of national banknotes and coins and adopts the currency of another country (usually the dollar) as a means of payment and unit of account. Journal of Economics, Finance and Administrative Science Vol 27 No 53, 2022 pp. Published in Journal of Economics, Finance and Administrative Science. The full terms of this licence maybe seen at http://creativecommons.org/licences/by/4.0/ legalcode

Methods

Results

Discussion

Conclusion