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On the Benefits of Dollarization when Stabilization Policy Is Not Credible and Financial Markets are Imperfect

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  • Mendoza, Enrique G.

Abstract

This paper argues that dollarization can be beneficial for countries where credit-market frictions and non-credible stabilization policies are large distortions on economic activity and welfare. A dynamic general-equilibrium model with these features is proposed for the case of a small open economy with a non-credible managed exchange-rate regime and a liquidity requirement that acts as an endogenous borrowing constraint. Assessing the experience of Mexico in the light of the quantitative predictions of this model suggests that, unless mechanisms to secure potential benefits of discretionary monetary policy can be implemented, dollarization is worth pursuing. The mean welfare gain of neutralizing both credibility distortions and credit frictions exceeds 9 percent in terms of the trend level of consumption per capita.

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 00-01.

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Date of creation: 2000
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Handle: RePEc:duk:dukeec:00-01

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Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
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Fax: (919) 684-8974
Web page: http://econ.duke.edu/

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Cited by:
  1. Artus P., 2001. "What Exchange - Rate System For Emerging Countries?," European Research Studies Journal, European Research Studies Journal, vol. 0(1-2), pages 27-60, January -.
  2. Ahmet Faruk Aysan, 2006. "The Role of Distribution of the Income Shares of Individuals in Tradables and Nontradables on Exchange Rate Fluctuations and Delay of Stabilizations," Working Papers 2006/11, Bogazici University, Department of Economics.
  3. Aysan, Ahmet Faruk, 2006. "Distributional Effects of Boom-Bust Cycles in Developing Countries with Financial Frictions," MPRA Paper 5484, University Library of Munich, Germany.
  4. Aloisio Araujo & Marcia Leon, 2002. "Speculative Attacks on Debts, Dollarization and Optimum Currency Areas," Working Papers Series 40, Central Bank of Brazil, Research Department.
  5. Carlos Gustavo Machicado, 2006. "Welfare Gains from Optimal Policy in a Partially Dollarized Economy," Development Research Working Paper Series 10/2006, Institute for Advanced Development Studies.
  6. Patrick Artus, 2003. "Local Currency or Foreign Currency Debt?," Revue économique, Presses de Sciences-Po, vol. 54(5), pages 1013-1031.
  7. Paasche, Bernhard, 2001. "Credit constraints and international financial crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 623-650, December.
  8. Cruz-Rodríguez, Alexis, 2005. "¿Es la dolarización oficial una opción real para las economías emergentes?
    [Is Official Dollarization a real option for emerging countries?]
    ," MPRA Paper 54353, University Library of Munich, Germany.
  9. Roger Craine, 2001. "Dollarization: An Irreversible Decision," International Finance 0103003, EconWPA.
  10. Enrique G. Mendoza, 2000. "On the Instability of Variance Decompositions of the Real Exchange Rate across Exchange-Rate-Regimes: Evidence from Mexico and the United States," NBER Working Papers 7768, National Bureau of Economic Research, Inc.

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