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Dollarization, bailouts, and the stability of the banking system

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  • Douglas Gale
  • Xavier Vives

Abstract

Central bank policy suffers from time-inconsistency when facing a banking crisis: A bailout is optimal ex post but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is preferable when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. A very severe moral hazard problem could make dollarization undesirable, however. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Proceedings with number 729.

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Length: 667-681
Date of creation: 2001
Date of revision:
Publication status: Published in Conference on Bank Structure and Competition (2001 : 37th) ; The financial net: costs, benefits, and implications for regulation
Handle: RePEc:fip:fedhpr:729

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Keywords: Dollar ; Banks and banking;

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References

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  1. Dewatripont, Mathias & Tirole, Jean, 1992. "Efficient Governance Structure : Implications for Banking Regulation," IDEI Working Papers 18, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
  3. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  4. Fry, Maxwell J, 1998. "Assessing Central Bank Independence in Developing Countries: Do Actions Speak Louder Than Words?," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 512-29, July.
  5. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall.
  6. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
  7. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  8. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  9. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-92, June.
  10. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, World Bank Group, vol. 6(3), pages 353-98, September.
  11. Ceyla Pazarbasioglu & Claudia Helene Dziobek, 1997. "Lessons From Systemic Bank Restructuring," IMF Working Papers 97/161, International Monetary Fund.
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