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Dollarization: An Irreversible Decision

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Author Info
Roger Craine (Department of Economics, University of California, Berkeley)
Abstract

After faithfully maintaining a fixed exchange rate and fully convertible currency for almost a decade Argentina still pays higher interest rates on peso denominated debt than on US dollar denominated debt. The interest rate spread is the price of keeping the option to devalue alive. Argentina has sufficient foreign reserves to defend the currency against any attack, but they could choose to devalue if the pain of maintaining the currency peg got too great. Investors fear devaluation and they charge Argentina for the option to devalue. In 1999 President Menem recommended "dollarizing" the economy. Dollarization extinguishes the option to devalue.

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Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number 1014.

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Date of creation: 02 Mar 2001
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Handle: RePEc:cdl:econwp:1014

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Related research
Keywords: dollarization; real options; exchange regimes;

References listed on IDEAS
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  1. Kenneth Kletzer & Mark M. Spiegel, 1996. "Speculative capital inflows and exchange rate targeting in the Pacific Basin: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, pages 409-435.
  2. Maurice Obstfeld, 1997. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Enrique G. Mendoza, 2000. "On the Benefits of Dollarization when Stabilization Policy is not Credible and Financial Markets are Imperfect," NBER Working Papers 7824, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Ozkan, F Gulcin & Sutherland, Alan, 1995. "Policy Measures to Avoid a Currency Crisis," Economic Journal, Royal Economic Society, vol. 105(429), pages 510-19, March. [Downloadable!] (restricted)
  5. Olivier Jeanne and Paul Masson., 1997. "Was the French Franc Crisis a Sunspot Equilibrium?," Center for International and Development Economics Research (CIDER) Working Papers C97-095, University of California at Berkeley.
  6. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Rust, John, 1996. "Numerical dynamic programming in economics," Handbook of Computational Economics, in: H. M. Amman & D. A. Kendrick & J. Rust (ed.), Handbook of Computational Economics, edition 1, volume 1, chapter 14, pages 619-729 Elsevier. [Downloadable!] (restricted)
  8. Alberto Alesina & Robert J. Barro, 2000. "Currency Unions," NBER Working Papers 7927, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Jeanne, Olivier, 1997. "Are currency crises self-fulfilling?: A test," Journal of International Economics, Elsevier, vol. 43(3-4), pages 263-286, November. [Downloadable!] (restricted)
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