Official Dollarization Research Articles

Does dollarization promote trade? Evidence from two recent episodes

ABSTRACT We quantify the trade-promotion effects of sharing a common currency by examining two recent episodes of official dollarization. To establish causal relationships, while avoiding the methodological criticisms of the previous literature on the issue (endogeneity and heteroskedasticity), we employ a differences-in-differences strategy that compares the pre- and post-dollarization trade flows between the United States and the two dollarizers (Ecuador and El Salvador) with the trade flows between the United States and the dollarizers’ neighbours. We find that the adoption of the dollar did not bring about any significant positive trade effects. Using product-level data we find that, while a few sectors saw positive increases, those instances are scattered and not the norm. Dollarization did not lead to increases in trade of previously non-traded goods either. Finally, we do not find any trade-promotion effects between Ecuador or El Salvador and the other dollarized country in the region (Panama) or between the newly dollarized countries themselves. These findings remain valid after we perform a battery of robustness tests, including PPML estimation.

US Policy on Dollarization of the World Economy

In its essence and content, dollarization is one of the keys and most significant phenomena of modern dynamically developing international monetary and financial relations. There are different theoretical approaches to determining the economic essence and content of the complex and contradictory phenomenon of dollarization. Different scientists have investigated the monetary nature of this phenomenon and have given a comparison of the concepts of official and partial dollarization, based on the degree of economic coverage of dollarization. In this research the process of official dollarization is considered on the example of Eurasian Economic Union (EAEU) member states. The paper examines the scale of financial dollarization in the EAEU member states, where, due to the loss of residents' confidence in the monetary policy and the national monetary unit, the functions of the national currency are partially replaced by the US dollar. Furthermore, the role of the US Federal Reserve in the implementation of dollarization of the foreign economies is analyzed. The article substantiates the intention of the US Federal Reserve to take steps to dollarize the foreign countries' economy in the context of the started process of de-dollarization of the world economy. The most active supporters of de-dollarization are Russia, China, and Iran. Their efforts are aimed at weakening the dominant position of the dollar as a key reserve currency, the currency of international settlements. In the current condition of the world economic development, it is unlikely to expect a weakening of the position of the US dollar, given the role of the US dollar in the trade of oil and petroleum products. The petrodollar system is the basis of the US dominance in the global financial system and the key to the stability of the US dollar. As a result, countries are forced to buy dollars in order to be able to purchase oil on the open market. While the demand for the US dollar will remain at a high level, it is not necessary to talk about the success of de-dollarization and the transition from an American-centered monetary and financial system to a polycentric one in the near future.

De‐dollarization in Zimbabwe: What lessons can be learned from other sub‐Saharan countries?

AbstractZimbabwe has had a tumultuous currency history. In 2019, it introduced a new currency. To make the new currency widely acceptable, International experience suggests that the introduction of a new currency, following a period of official dollarization, requires the introduction of policies that go beyond just changing the law. This paper, aims to draw lessons from other African countries on how to de‐dollarize effectively. Using various econometric techniques and a new database, this paper documents the pattern of dollarization in African economies over the last decade and assesses the determinants of dollarization compared to the rest of the world. It illustrates that despite an improved macroeconomic environment, dollarization remains elevated, likely due to the region's volatile history. This indicates that dollarization should decline going forward provided that macroeconomic stability is achieved and preserved. The lessons for Zimbabwe are also that it's important to use legal, regulatory and market based incentives to nudge de‐dollarization, and that it will take time.

Money demand and seignorage maximization before the end of the Zimbabwean dollar

The delayed end to Zimbabwe's hyperinflation in 2009 gave rise to an official dollarization. Before then, the Reserve Bank of Zimbabwe (RBZ) operated on the correct side of the inflation tax Laffer curve. Estimated seignorage maximizing rates derive from Bayesian, time-varying parameter, structural vector autoregressions. Monthly changes in the ratio of prices for the Old Mutual insurance company's shares, which trade in London and Harare, serve as the measure of inflation from 1999 to 2008. Orthogonalized impulse response functions indicate that monthly seignorage maximizing rates ranged from 242% to 315% and exceeded all monthly inflation rates.

Dollarization and Trade Through the Lens of History

This paper makes a comparison between official dollarization and the classic gold standard by studying the effects of both on trade. Under this scheme, I have been able to assess the cases of Ecuador and El Salvador: two contemporary examples of official dollarization. In the case of Ecuador, it happened in 2000 after a financial crisis and for El Salvador it occurred when the country was under stable macroeconomic conditions in 2001. One of the benefits of the classic gold standard was its effects on trade, the same happening with official dollarization. Through a synthetic control analysis, I show the benefits of official dollarization in trade under the common currency framework. Results for Ecuador show that official dollarization has increase bilateral trade with the US by 43% over 14 years. Results for El Salvador show an increase of bilateral trade with the US of 76% over 13 years. What drives this difference? During the classic gold standard period (1870-1914) different monetary unions were formed having diverse effects on trade. One reason for this may be business cycle coordination among members while another could be structural reforms prior to adopting the system along with institutions, these lessons may be extrapolated to dollarization.

Dependência Monetária e Dolarização Oficial: o caso de Timor Leste

O artigo investiga e analisa os efeitos da dependência monetária através da dolarização oficial em economias nacionais. Realizou-se o estudo do caso de Timor Leste, que tem uma economia dolarizada desde 2000. Percebeu-se que, pelo menos para esse caso, a dolarização parece estar implicado mais desvantagens do que vantagens.

An analysis of the official dollarization regime in Montenegro: theoretical approaches and empirical evidence

An analysis of the official dollarization regime in Montenegro: theoretical approaches and empirical evidence

How Strong is the Case for Dollarization in Central America? An Empirical Analysis of Business Cycles, Credit Market Imperfections and the Exchange Rate

In this paper, we contrast two different views in the debate on official dollarization. The Mundell (1961) framework of optimal currency areas and a model on boom-bust cycles, by Schneider and Tornell (2004), who take account of credit market imperfections prevalent in middle income countries. We highlight that the role of the exchange rate is strikingly different in the two models. While in the Mundell framework the exchange rate is expected to smooth the business cycle, the other model predicts that the exchange rate plays an amplifying role. We empirically evaluate both models for eight highly dollarized Central American economies, and find that the main benefit of official dollarization derives from avoiding a mismatch between foreign currency liabilities and domestic revenues, as well as the boom-bust episodes that are likely to follow from it. Using a new method of Cubadda (1999, 2007), we furthermore test for cyclical comovement and reject the hypothesis that the countries form an optimal currency area with the United States according to the Mundell definition.

The Impact of Dollarization and Currency Boards on Income and Inflation: A Synthetic Control Analysis

We use the synthetic control method (SCM) to estimate the effect of official dollarization in Ecuador and quasi-dollarization, in the form of a currency board, in Argentina. We show that these monetary arrangements were effective at controlling inflation in these two countries. Interestingly, in contrast with previous research, we find these policies had no impact on real income. Despite the success of these policies, Argentina abandoned its currency board in 2002, devalued its currency, and repudiated much of its outstanding government debt causing renewed inflation and a loss of significant consumer wealth. Ecuador, conversely, continues to operate under dollarization, fourteen years after implementation. We discuss the roles of labor market adjustments and fiscal discipline as explanations for these divergent outcomes.

How strong is the case for dollarization in Central America? An empirical analysis of business cycles, credit market imperfections and the exchange rate

In this paper, we contrast two different views in the debate on official dollarization. The Mundell framework of optimum currency areas and a model on boom–bust cycles, by Schneider and Tornell, who take account of credit market imperfections prevalent in middle income countries. We highlight that the role of the exchange rate is strikingly different in the two models. Although in the Mundell framework, the exchange rate is expected to smooth the business cycle, the other model predicts that the exchange rate plays an amplifying role. We empirically evaluate both models for eight highly dollarized Central American economies. We document the existence of credit market imperfections and find that shocks from the exchange rate indeed amplify business cycles in these countries. Using a new method of Cubadda, we furthermore test for cyclical comovement and reject the hypothesis that the countries form an optimum currency area with the United States according to the Mundell definition. Copyright © 2011 John Wiley & Sons, Ltd.

Official Dollarization as a Monetary Regime: Its Effects on El Salvador

This paper examines El Salvador’s transition to official dollarization by comparing aspects of this regime to the fixed exchange rate regime prevailing in the 1990s. Commercial bank interest rates are analyzed under an uncovered interest parity framework, and it is found that dollarization lowered rates by 4 to 5 percent by reducing currency risk. This has generated net annual savings averaging ½ percent of GDP for the private sector and ¼ percent of GDP for the public sector (net of the losses from foregone seigniorage). Estimated Taylor rules show a strong positive association between Salvadoran output and U.S. Federal Reserve policy since dollarization, implying that this policy has served to stabilize economic activity more than it did under the peg and more than policy rates in Central American countries with independent monetary policy have done. Dollarization does not appear to have affected the transmission mechanism, as pass-through of monetary policy to commercial interest rates has been similar to pass-through under the peg and in the rest of Central America.

Official Dollarization As a Monetary Regime: Its Effectson El Salvador

This paper examines El Salvador’s transition to official dollarization by comparing aspects of this regime to the fixed exchange rate regime prevailing in the 1990s. Commercial bank interest rates are analyzed under an uncovered interest parity framework, and it is found that dollarization lowered rates by 4 to 5 percent by reducing currency risk. This has generated net annual savings averaging ½ percent of GDP for the private sector and ¼ percent of GDP for the public sector (net of the losses from foregone seigniorage). Estimated Taylor rules show a strong positive association between Salvadoran output and U.S. Federal Reserve policy since dollarization, implying that this policy has served to stabilize economic activity more than it did under the peg and more than policy rates in Central American countries with independent monetary policy have done. Dollarization does not appear to have affected the transmission mechanism, as pass-through of monetary policy to commercial interest rates has been similar to pass-through under the peg and in the rest of Central America.

Why dollarization didn’t succeed: Comparing credibility and the impact of real shocks on small open economies

This paper compares credibility and the impact of real shocks on a small open economy operating under two opposite corner solutions: a flexible exchange rate and official dollarization. Using an asymmetric two-country model, we show that although dollarization is an effective device to achieve price stability and avoid credibility problems, small open economies might be better off under a flexible regime than under dollarization following any symmetric or asymmetric shock. We also show that even when a small economy follows “fear of floating” practices, the costs of stabilization are smaller than those under dollarization. We interpret these results as consistent with the demise of the dollarization debate.

Implementing official Dollarization

This paper identifies key aspects that countries willing to officially dollarize must necessarily address. Based on country experiences, it discusses the critical institutional bases that are necessary to unilaterally introduce a new legal tender, describes the relevant operational issues to smooth the transition toward the use of the new currency, and identifies key structural reforms that are necessary to favor the sustainability over time of this monetary regime. The paper is aimed at providing preliminary guidance to policy makers and practitioners adopting official dollarization. The paper does not take a position on how appropriate this monetary arrangement is. Experiences from adopting dollarization in Ecuador, El Salvador, Kosovo, Montenegro, and Timor-Leste are illustrated briefly.

Implementing Official Dollarization

This paper identifies key aspects that countries willing to officially dollarize must necessarily address. Based on country experiences, it discusses the critical institutional bases that are necessary to unilaterally introduce a new legal tender, describes the relevant operational issues to smooth the transition toward the use of the new currency, and identifies key structural reforms that are necessary to favor the sustainability over time of this monetary regime. The paper is aimed at providing preliminary guidance to policy makers and practitioners adopting official dollarization. The paper does not take a position on how appropriate this monetary arrangement is. Experiences from adopting dollarization in Ecuador, El Salvador, Kosovo, Montenegro, and Timor-Leste are illustrated briefly.

Official dollarization in El Salvador and the inflation–inflation uncertainty nexus

This study extends the literature on the relationship between inflation and inflation uncertainty by examining the impact of official dollarization on inflation uncertainty in El Salvador. The ARIMA–GARCH model reveals that official dollarization significantly reduces the degree of volatility persistence in response to inflationary shocks. However, based on Granger causality tests, if inflation should increase there would be an increase in inflation uncertainty as suggested by the Friedman–Ball hypothesis.

Dollarization and Pakistan Perspective

Dollarization occurs when residents of a country extensively use the U.S. dollar or another foreign currency alongside or instead of the domestic currency. Unofficial dollarization occurs when individuals hold foreign-currency bank deposits or notes (paper money) to protect against high inflation in the domestic currency. Official dollarization occurs when a government adopts foreign currency as the predominant or exclusive legal tender. Unofficial dollarization has existed in many countries for years. It has attracted much study by economists, but far less political attention because it is to a certain extent beyond the control of governments. Dollarization has been in the news lately because of interest in official dollarization. In early 1999 the government of Argentina stated that it sought a formal agreement with the United States to become officially dollarized. Argentina or any other country can become officially dollarized even without a formal agreement, but there may be economic and political benefits to a formal agreement. Argentina's action sparked discussion of official dollarization in other Latin American countries, including Ecuador. On January 9, 2000, Ecuador's president proposed dollarization as a way of helping his country out of a deep recession and political turmoil. On January 21 political unrest forced him out of office, but his successor has expressed support for dollarization. As of late January it remains to be seen whether Ecuador will implement dollarization. On January 24, administrators of the United Nations announced that for the time being, the dollar will be the official currency of East Timor, which recently regained independence from Indonesia.

Dealing with multiple currencies: what options for the transitional economies of Southeast Asia?

There is a spectrum of policy options available in dealing with dollarization in the transitional economies of Southeast Asia. These range from official dollarization at one end and enforced de-dollarization at the other. In between lie: currency board arrangements (CBAs), single currency options; and the muddling through approach. Both official dollarization and CBAs are not viable options for these countries. Official dollarization is politically untenable, while implementing a credible CBA is currently beyond the financial capacity of these countries. The single currency option remains somewhat vague in terms of detail, in relation to both design and time frame, and the region is unlikely to meet Optimal Currency Area (OCA) criteria. Lao PDR attempted to enforce de-dollarization in 1997, but the result was counter-productive. The muddling through but accelerating reforms approach appears to be the most realistic option. This approach views the multiple currency phenomenon (MCP) not so much as the problem, but rather as a symptom. The causes of the problem emanate from macroeconomic instability, political uncertainty, an underdeveloped financial and monetary system, and weak legal and institutional systems. Addressing these problems directly should eventually remove the symptom in the form of the MCP.

An assessment of the case for monetary union or official dollarization in five Latin American countries

We use a data set covering the whole period of Argentina's currency board and most of that spanned by the Mercosur trade agreement to examine the case for either a Latin American monetary union or monetary union with the USA (through official dollarization). Our econometric evidence – using VAR techniques – indicates that macroeconomic shocks are so highly asymmetric between our set of Latin American countries and the USA as to strongly question the advisability of official dollarization. As macroeconomic shocks are a little more positively correlated within our set of Latin American countries, a stronger case can be made for a Latin American monetary union. Even so, we remain rather doubtful.

Full Dollarization: A Last Resort Solution to Financial Instability in Emerging Countries?

This paper will examine the question of official dollarization. To clarify the discussion, a taxonomy of dollarization regimes is drawn up in order to make an inventory of officially dollarized countries, territories and dependencies. The foundations for adopting full dollarization are analysed through three elements: an account of the limits to corner solutions, the identification of the economic contexts which are favourable to the adoption of foreign currencies and the reasons behind the legitimacy crisis of national currencies. To determine what is at stake in such decisions, cost advantage analysis mentions, first of all, the expected benefits highlighted by the advocates of complete dollarization. A detailed study of its potential impact will then allow us to evaluate the induced costs of the disappearance of national currencies. Finally, by looking at emerging countries which have adopted this exchange regime, the limits of adopting such a solution are underlined, particularly by the fact that the ...