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Liquidity shocks and the dollarization of a banking system

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  • Machicado, Carlos Gustavo

Abstract

This paper shows how uncertainty about liquidity demand can lead to a high degree of dollarization in the banking system. I study a model where the demand for currency in each period is random, and where it is easier for banks to borrow in local currency in times of crisis than in dollars. Banks choose a portfolio composed of local currency, dollars, and real loans. Compared to the anticipated transactions demand for each currency, I show that the bank will hold a relatively large amount of dollars and a relatively small amount of local currency. I also show the existence of a dollarization multiplier: as the anticipated transactions demand for dollars increases, the dollarization of the banking sector increases more than proportionately.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 30 (2008)
Issue (Month): 1 (March)
Pages: 369-381

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Handle: RePEc:eee:jmacro:v:30:y:2008:i:1:p:369-381

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Web page: http://www.elsevier.com/locate/inca/622617

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  1. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
  2. Joe Haslag & Antoine Martin, 2003. "Optimality of the Friedman Rule in Overlapping Generations Model with Spatial Separation," Working Papers 0306, Department of Economics, University of Missouri.
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  4. Marco Terrones & Luis Catão, 2000. "Determinants of Dollarization - The Banking Side," IMF Working Papers 00/146, International Monetary Fund.
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  7. De Nicolo, Gianni & Honohan, Patrick & Ize, Alain, 2003. "Dollarization of the banking system : good or bad?," Policy Research Working Paper Series 3116, The World Bank.
  8. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  9. Eduardo Moron & Juan F. Castro & Diego Winkelried, 2004. "Assessing Financial Vulnerability in Partially Dollarized Economies," International Finance 0406002, EconWPA.
  10. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  11. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  12. Juan Antonio Morales Anaya, 2003. "Dollarization of assets and liabilities: Problem or solution?. The case of Bolivia," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 6(1), pages 7-39, June.
  13. Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2004. "The Role of Money in Two Alternative Models: When is the Friedman Rule Optimal, and Why?," Staff General Research Papers 11950, Iowa State University, Department of Economics.
  14. Stacey L. Schreft & Bruce D. Smith, 2002. "The conduct of monetary policy with a shrinking stock of government debt," Proceedings, Federal Reserve Bank of Cleveland, pages 848-886.
  15. Gaetano Antinolfi & Elisabeth Huybens & Todd Keister, 2000. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Working Papers 0001, Centro de Investigacion Economica, ITAM.
  16. Martin Uribe, 1995. "Hysteresis in a simple model of currency substitution," International Finance Discussion Papers 509, Board of Governors of the Federal Reserve System (U.S.).
  17. Broda, Christian & Yeyati, Eduardo Levy, 2006. "Endogenous Deposit Dollarization," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 963-988, June.
  18. Bruce D. Smith, 2002. "Monetary Policy, Banking Crises, and the Friedman Rule," American Economic Review, American Economic Association, vol. 92(2), pages 128-134, May.
  19. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May.
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Cited by:
  1. Andreev, M. & Pil'nik, N. & Pospelov, I., 2009. "Rational Expectation Model of Modern Russian Banking System and the Strong Turnpike Property," Journal of the New Economic Association, New Economic Association, issue 3-4, pages 72-96.

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