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Floating, Official Dollarization, and Macroeconomic Volatility:An Analysis for the Chilean Economy

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  • Roberto Duncan

Abstract

This paper contrasts the volatility of the main macroeconomic variables of a small open economy in two environments: an official dollarization (OD) scheme and a flexible exchange regime (FER). A simple DSGE model calibrated for the Chilean economy is used as a laboratory to study the implications of these regimes on the standard deviations of key variables. Welfare implications are also analyzed for a central bank that it is concerned with output and inflation volatility. Our findings show that OD results in: higher real volatility due to the absence of ountercyclical monetary policy; lower inflation volatility because of a less volatile foreign interest rate; and, from a welfare perspective, OD is dominated by a FER when the central bank weighs considerably the deviations of inflation and output from the steady state. Also, OD implies higher fiscal deficit volatility as a consequence of higher tax revenue volatility, and a higher reaction to terms-of-trade shocks.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 249.

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Date of creation: Dec 2003
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Handle: RePEc:chb:bcchwp:249

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  1. Ellen R. McGrattan, 1991. "The macroeconomic effects of distortionary taxation," Discussion Paper / Institute for Empirical Macroeconomics 37, Federal Reserve Bank of Minneapolis.
  2. Sebastian Edwards & I. Igal Magendzo, 2001. "Dollarization, Inflation and Growth," NBER Working Papers 8671, National Bureau of Economic Research, Inc.
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  4. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2002. "A Decade Lost and Found: Mexico and Chile in the 1980s," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 166-205, January.
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  8. Roberto Duncan, 2002. "How Well Does a Monetary Dynamic Equilibrium Model Account for Chilean Data?," Working Papers Central Bank of Chile 190, Central Bank of Chile.
  9. Raphael Bergoeing & Raimundo Soto, 2002. "Testing Real Business Cycle Models in an Emerging Economy," Documentos de Trabajo 126, Centro de Economía Aplicada, Universidad de Chile.
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  17. Zeljko Bogetic, 2005. "Official Dollarization: Current Experiences and Issues, Cato Journal, Vol. 20, No. 2 (Fall 2000), 179-213," International Finance 0510006, EconWPA.
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  20. Sebastian Edwards, 2001. "Dollarization and Economic Performance: An Empirical Investigation," NBER Working Papers 8274, National Bureau of Economic Research, Inc.
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