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Real Dollarization, Financial Dollarization, and Monetary Policy

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  • Alain Ize
  • Eric Parrado

Abstract

This paper explores the interaction of real dollarization (dollar indexing of wages), financial dollarization (dollar denomination of financial contracts) and monetary policy in a general equilibrium model with real shocks. Real dollarization is avoided as long as the home monetary authorities perform optimally (i.e., they maximize local welfare). Instead, dollarization increases when central banks perform poorly, and even more so when the correlation between domestic and external shocks is high, since in this case the (presumably optimal) foreign monetary policy guarantees a better level of protection against macroeconomic uncertainty. While real dollarization contributes to financial dollarization, important asymmetries between the two arise.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 375.

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Date of creation: Oct 2006
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Handle: RePEc:chb:bcchwp:375

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  1. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2004. "A corporate balance-sheet approach to currency crises," Journal of Economic Theory, Elsevier, vol. 119(1), pages 6-30, November.
  2. Giancarlo Corsetti & Paolo Pesenti, 2002. "Self-validating optimum currency areas," Staff Reports 152, Federal Reserve Bank of New York.
  3. Bacchetta, Philippe & Van Wincoop, Eric, 2002. "A theory of the currency denomination of international trade," Working Paper Series 0177, European Central Bank.
  4. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
  5. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," NBER Working Papers 10015, National Bureau of Economic Research, Inc.
    • Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," CEMA Working Papers 594, China Economics and Management Academy, Central University of Finance and Economics.
  6. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  7. Alberto Alesina & Robert Barro & Silvana Tenreyro, 2002. "Optimal Currency Areas," Harvard Institute of Economic Research Working Papers 1958, Harvard - Institute of Economic Research.
    • Alberto Alesina & Robert J. Barro & Silvana Tenreyro, 2003. "Optimal Currency Areas," NBER Chapters, in: NBER Macroeconomics Annual 2002, Volume 17, pages 301-356 National Bureau of Economic Research, Inc.
  8. Alain Ize & Eric Parrado, 2002. "Dollarization, Monetary Policy, and the Pass-Through," IMF Working Papers 02/188, International Monetary Fund.
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