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Dollarization and financial integration

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  • Arellano, Cristina
  • Heathcote, Jonathan

Abstract

How does a country's exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government responds to shocks by adjusting monetary policy and foreign borrowing. Sovereign borrowing is subject to endogenous limits, which ensure repayment when the default punishment corresponds to financial autarky. Dollarizing implies renouncing monetary policy, but can make access to international debt markets more valuable, thereby loosening borrowing constraints. This mechanism linking dollarization to financial integration is consistent with observed declines in spreads on foreign-currency debt in countries adopting the dollar or the euro.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 145 (2010)
Issue (Month): 3 (May)
Pages: 944-973

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Handle: RePEc:eee:jetheo:v:145:y:2010:i:3:p:944-973

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Web page: http://www.elsevier.com/locate/inca/622869

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Keywords: Exchange rate regime Borrowing limits Dollarization Debt policy;

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Citations

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Cited by:
  1. Samir Jahjah & Bin Wei & Vivian Zhanwei Yue, 2012. "Exchange rate policy and sovereign bond spreads in developing countries," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 1049, Board of Governors of the Federal Reserve System (U.S.).
  2. Michael Kumhof, 2004. "Fiscal Crisis Resolution: Taxation Versus Inflation," 2004 Meeting Papers 874, Society for Economic Dynamics.
  3. Krzysztof Makarski, 2009. "Dollarization as a Signaling Device," National Bank of Poland Working Papers 63, National Bank of Poland, Economic Institute.
  4. Schmitz, Birgit & von Hagen, Jürgen, 2011. "Current account imbalances and financial integration in the euro area," Journal of International Money and Finance, Elsevier, Elsevier, vol. 30(8), pages 1676-1695.
  5. Eduardo Borensztein & Ugo Panizza, 2008. "The Costs of Sovereign Default," IMF Working Papers 08/238, International Monetary Fund.
  6. Betty C. Daniel & Christos Shiamptanis, 2010. "Sovereign Default Risk in a Monetary Union," Working Papers, Central Bank of Cyprus 2010-3, Central Bank of Cyprus.
  7. Roc Armenter & Martin Bodenstein, 2006. "Does the time inconsistency problem make flexible exchange rates look worse than you think?," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 865, Board of Governors of the Federal Reserve System (U.S.).
  8. Slavov, Slavi T., 2009. "Do common currencies facilitate the net flow of capital among countries?," The North American Journal of Economics and Finance, Elsevier, vol. 20(2), pages 124-144, August.
  9. Asonuma, Tamon, 2014. "Sovereign defaults, external debt and real exchange rate dynamics," MPRA Paper 55133, University Library of Munich, Germany.
  10. Adam, Klaus & Grill, Michael, 2013. "Optimal sovereign default," Discussion Papers 09/2013, Deutsche Bundesbank, Research Centre.

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