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The Twin Risks in the Dollarization Debate: Country and Devaluation Risks

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  • Pablo Druck
  • Eduardo Morón
  • Ernesto Stein

Abstract

This paper discusses dollarization from the perspective of the relation between country and devaluation risk. In the absence of balance sheet effects, we find that a full dollarization of an economy increases its country risk. On the other hand, when balance sheet effects are present, the full dollarization could reduce country risk. The link between these two risks is based on the government’s financial needs. In this paper government devalue the currency for fiscal purposes. Consequently, a full dollarization closes this avenue transferring the whole cost to bond holders. This paper stresses the idea that dollarization is at the very end a fiscal issue. Empirically, using the ratio of foreign currency deposit on total deposits as a proxy to the balance sheet effect, the paper tests the importance of this variable on country risk. We find that the balance sheet has a positive effect on country risk, in other words, country with higher balance sheet effect should have higher country risk.

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Bibliographic Info

Paper provided by Universidad del CEMA in its series CEMA Working Papers: Serie Documentos de Trabajo. with number 198.

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Date of creation: Sep 2001
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Handle: RePEc:cem:doctra:198

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  1. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
  2. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  3. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and the Choice of Exchange Rate Regime," IDB Publications 4128, Inter-American Development Bank.
  4. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and Choice of Exchange Rate Regime," Research Department Publications 4170, Inter-American Development Bank, Research Department.
  5. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
  6. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
  7. Roberto Chang & Andres Velasco, 2002. "Dollarization: Analytical Issues," NBER Working Papers 8838, National Bureau of Economic Research, Inc.
  8. Pablo Andres Neumeyer & Juan Pablo Nicolini, 2003. "Using Balance Sheet to identify sovereign default and devaluation risk," Department of Economics Working Papers 009, Universidad Torcuato Di Tella.
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Cited by:
  1. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
  2. Dorbec, Anna, 2005. "Choice of the substitution currency in Russia: How to explain the dollar's dominance?," BOFIT Discussion Papers 15/2005, Bank of Finland, Institute for Economies in Transition.
  3. Morón, Eduardo & Winkelried, Diego, 2002. "Reglas de política monetaria para economías financieramente vulnerables," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 8, pages 49-76.

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