How Strong is the Case for Dollarization in Central America? An Empirical Analysis of Business Cycles, Credit Market Imperfections and the Exchange Rate
AbstractIn this paper, we contrast two different views in the debate on official dollarization. The Mundell (1961) framework of optimal currency areas and a model on boom-bust cycles, by Schneider and Tornell (2004), who take account of credit market imperfections prevalent in middle income countries. We highlight that the role of the exchange rate is strikingly different in the two models. While in the Mundell framework the exchange rate is expected to smooth the business cycle, the other model predicts that the exchange rate plays an amplifying role. We empirically evaluate both models for eight highly dollarized Central American economies, and find that the main benefit of official dollarization derives from avoiding a mismatch between foreign currency liabilities and domestic revenues, as well as the boom-bust episodes that are likely to follow from it. Using a new method of Cubadda (1999, 2007), we furthermore test for cyclical comovement and reject the hypothesis that the countries form an optimal currency area with the United States according to the Mundell definition.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Institute of Empirical Economic Research in its series Working Papers with number 83.
Date of creation: 05 Aug 2010
Date of revision:
dollarization; real exchange rate; business cycle comovement; serial correlation; common feature; boom-bust cycles; credit market imperfections; Central America;
Other versions of this item:
- Nannette Lindenberg & Frank Westermann, 2012. "How strong is the case for dollarization in Central America? An empirical analysis of business cycles, credit market imperfections and the exchange rate," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 17(2), pages 147-166, 04.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
- O54 - Economic Development, Technological Change, and Growth - - Economywide Country Studies - - - Latin America; Caribbean
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-12-04 (All new papers)
- NEP-MAC-2010-12-04 (Macroeconomics)
- NEP-MON-2010-12-04 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Reinhart, Carmen & Kaminsky, Graciela, 1999.
"The twin crises: The causes of banking and balance of payments problems,"
14081, University Library of Munich, Germany.
- 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.
- Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
- Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001.
"Lending Booms: Latin America and the World,"
Journal of LACEA Economia,
LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
- Gourinchas, Pierre-Olivier & Landerretche, Oscar & Valdés, Rodrigo, 2001. "Lending Booms: Latin America and the World," CEPR Discussion Papers 2811, C.E.P.R. Discussion Papers.
- Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001. "Lending Booms: Latin America and the World," NBER Working Papers 8249, National Bureau of Economic Research, Inc.
- Gianluca Cubadda, 2007.
"A Unifying Framework for Analysing Common Cyclical Features in Cointegrated Time Series,"
CEIS Research Paper
102, Tor Vergata University, CEIS.
- Cubadda, Gianluca, 2007. "A unifying framework for analysing common cyclical features in cointegrated time series," Computational Statistics & Data Analysis, Elsevier, vol. 52(2), pages 896-906, October.
- Robert Mundell, 2000.
"Currency Areas, Exchange Rate Systems and International Monetary Reform,"
Journal of Applied Economics,
Universidad del CEMA, vol. 0, pages 217-256, November.
- Robert Mundell, 2000. "Currency Areas, Exchange Rate Systems and International Monetary Reform," CEMA Working Papers: Serie Documentos de Trabajo. 167, Universidad del CEMA.
- Luis Ignacio JÃ¡come, 2008. "Central Bank Involvement in Banking Crises in Latin America," IMF Working Papers 08/135, International Monetary Fund.
- Freund, Caroline & Spatafora, Nikola, 2008. "Remittances, transaction costs, and informality," Journal of Development Economics, Elsevier, vol. 86(2), pages 356-366, June.
- Kaminsky, Graciela L & Reinhart, Carmen M, 1998.
"Financial Crises in Asia and Latin America: Then and Now,"
American Economic Review,
American Economic Association, vol. 88(2), pages 444-48, May.
- Reinhart, Carmen & Kaminsky, Graciela, 1998. "Financial crises in Asia and Latin America: Then and now," MPRA Paper 13877, University Library of Munich, Germany.
- Cubadda, Gianluca, 1999. "Common Cycles in Seasonal Non-stationary Time Series," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 14(3), pages 273-91, May-June.
- Helge Berger & Henrik Jensen & Guttorm Schjelderup, 2001.
"To Peg or Not To Peg? A Simple Model of Exchange Rate Regime Choice In Small Economies,"
CESifo Working Paper Series
468, CESifo Group Munich.
- Berger, Helge & Jensen, Henrik & Schjelderup, Guttorm, 2001. "To peg or not to peg?: A simple model of exchange rate regime choice in small economies," Economics Letters, Elsevier, vol. 73(2), pages 161-167, November.
- Gourieroux, Christian & Peaucelle, Irina, 1989. "Detecting a long run relationship (with an application to the p.p.p. hypothesis)," CEPREMAP Working Papers (Couverture Orange) 8902, CEPREMAP.
- Yin-Wong Cheung & Jude Yuen, 2004.
"An Output Perspective on a Northeast Asia Currency Union,"
CESifo Working Paper Series
1250, CESifo Group Munich.
- Yin-wong Cheung & Jude Yuen, 2005. "An Output Perspective on a Northeast Asia Currency Union," Working Papers 162005, Hong Kong Institute for Monetary Research.
- Aaron Tornell & Frank Westermann, 2005.
"Boom-Bust Cycles and Financial Liberalization,"
MIT Press Books,
The MIT Press,
edition 1, volume 1, number 0262201593, June.
- Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises: A New Database," IMF Working Papers 08/224, International Monetary Fund.
- Vahid, Farshid & Engle, Robert F., 1997. "Codependent cycles," Journal of Econometrics, Elsevier, vol. 80(2), pages 199-221, October.
- Edgar L. Feige & Vedran Šošiæ & Michael Faulend & Velimir Šonje, 2002. "Unofficial Dollarization in Latin America: Currency Substitution, Network Externalities and Irreversibility," International Finance 0205002, EconWPA.
- Frederic S. Mishkin & Miguel A. Savastano, 2000.
"Monetary Policy Strategies for Latin America,"
NBER Working Papers
7617, National Bureau of Economic Research, Inc.
- Urga, Giovanni, 2007. "Common Features in Economics and Finance: An Overview of Recent Developments," Journal of Business & Economic Statistics, American Statistical Association, vol. 25, pages 2-11, January.
- Ahmed, Shaghil, 2003. "Sources of economic fluctuations in Latin America and implications for choice of exchange rate regimes," Journal of Development Economics, Elsevier, vol. 72(1), pages 181-202, October.
- Cheung, Yin-Wong & Lai, Kon S, 1995. "Lag Order and Critical Values of the Augmented Dickey-Fuller Test," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 277-80, July.
- Ã…ke LÃ¶nnberg & Luis Ignacio JÃ¡come, 2010. "Implementing Official Dollarization," IMF Working Papers 10/106, International Monetary Fund.
- Tim Willems, 2011. "Using Dollarized Countries to Analyze the Effects of US Monetary Policy Shocks," 2011 Meeting Papers 200, Society for Economic Dynamics.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Renate Ehmke).
If references are entirely missing, you can add them using this form.