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Liability Dollarization and Fear of Floating

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  • Quoc Hung Nguyen

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    (University of British Columbia)

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    Abstract

    This paper addresses the question of whether fear of floating in developing countries can be justified as optimal discretionary monetary policy in a dollarized economy where intermediate goods importers face Bernanke-type credit constraint. Exchange rate depreciation not only worsens the net-worth but also increases the financing amount of importer firms who borrow in foreign currency, hence exaggerating the borrowing finance premium. Besides, because of high exchange rate passthrough, fluctuations in the exchange rate also have strong impacts on domestic price levels and production. These effects, together, magnify the macroeconomic consequences of the economy that experiences external and domestic technology shocks. It can be shown that the fixed exchange rate regime dominates the inflation targeting regime in both the role of cushioning shocks and in welfare terms.

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    Bibliographic Info

    Paper provided by Development and Policies Research Center (DEPOCEN), Vietnam in its series Working Papers with number 16.

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    Length: 34 pages
    Date of creation: Oct 2007
    Date of revision: May 2008
    Handle: RePEc:dpc:wpaper:1607

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    Related research

    Keywords: Liability Dollarizaion; Fear of Floating; Imported Goods;

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    1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
    2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Staff Report 227, Federal Reserve Bank of Minneapolis.
    3. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2014. "Addicted to Dollars," Annals of Economics and Finance, Society for AEF, vol. 15(1), pages 1-50, May.
    4. Michael B. Devereux & Philip Lane, 2001. "Exchange Rates and Monetary Policy in Emerging Market Economies," Trinity Economics Papers 200111, Trinity College Dublin, Department of Economics.
    5. Braggion, Fabio & Christiano, Lawrence J. & Roldos, Jorge, 2009. "Optimal monetary policy in a [`]sudden stop'," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 582-595, May.
    6. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
    7. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
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