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Dollarization, Monetary Policy, and the Pass-Through

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  • Alain Ize
  • Eric Parrado

Abstract

This paper explores how real dollarization (dollar indexing of wages), financial dollarization (dollar denomination of financial contracts), and monetary policy interact in a general equilibrium, new open-economy macroeconomics model with real shocks. Real dollarization is avoided as long as the home monetary authorities conduct monetary policy optimally (maximize local welfare). Suboptimal monetary policies are more likely to induce real dollarization 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 were found.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 02/188.

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Length: 34
Date of creation: 01 Nov 2002
Date of revision:
Handle: RePEc:imf:imfwpa:02/188

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Related research

Keywords: Dollarization; Exchange rates; monetary policy; inflation; monetary authorities; optimal monetary policy; monetary independence; monetary fund; monetary regime; monetary management; monetary authority; money demand; monetary regimes; monetary policies; central bank; monetary shock; aggregate demand; monetary response; monetary policy regime; money stocks; export prices; capital flight; money balances; foreign monetary shock; import prices; monetary policy reaction function; exported goods; monetary shocks; cost of credit; producer prices; monetary policy rule; monetary theory; balance sheets; domestic monetary authorities; exchange rate depreciation; money supply; open economy macroeconomics; monetary economics; floating exchange rates;

References

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  1. Honohan, Patrick & Shi, Anging, 2001. "Deposit dollarization and the financial sector in emerging economies," Policy Research Working Paper Series 2748, The World Bank.
  2. Alberto Alesina & Robert Barro & Silvana Tenreyro, 2002. "Optimal Currency Areas," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1958, Harvard - Institute of Economic Research.
  3. P. Bacchetta & E. van Wincoop, 2002. "A Theory of the Currency Denomination of International Trade," DNB Staff Reports (discontinued), Netherlands Central Bank 75, Netherlands Central Bank.
  4. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, Elsevier, vol. 44(7), pages 1389-1408, June.
  5. Devereux, Michael B & Engel, Charles M, 2000. "Monetary Policy In The Open Economy Revisited: Price Setting Rules And Exchange Rate Flexibility," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2454, C.E.P.R. Discussion Papers.
  6. Miguel A. Savastano, 1996. "Dollarization in Latin America," IMF Working Papers, International Monetary Fund 96/4, International Monetary Fund.
  7. Michael Devereux & Charles Engel, 2000. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibiity," Discussion Papers in Economics at the University of Washington, Department of Economics at the University of Washington 0016, Department of Economics at the University of Washington.
  8. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1131, C.E.P.R. Discussion Papers.
  9. Giancarlo Corsetti & Paolo Pesenti, 2002. "Self-Validating Optimum Currency Areas," NBER Working Papers 8783, National Bureau of Economic Research, Inc.
  10. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(2), pages 421-445, May.
  11. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics, Boston College Department of Economics 438, Boston College Department of Economics, revised 15 Nov 1999.
  12. Dalia Hakura & Ehsan U. Choudhri, 2001. "Exchange Rate Pass-Through to Domestic Prices," IMF Working Papers, International Monetary Fund 01/194, International Monetary Fund.
  13. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?," NBER Working Papers 8934, National Bureau of Economic Research, Inc.
  14. Ilan Goldfajn & Sérgio Ribeiro da Costa Werlang, 2000. "The Pass-through from Depreciation to Inflation: A Panel Study," Working Papers Series, Central Bank of Brazil, Research Department 5, Central Bank of Brazil, Research Department.
  15. Eric Parrado & Andres Velasco, 2002. "Optimal Interest Rate Policy in a Small Open Economy," NBER Working Papers 8721, National Bureau of Economic Research, Inc.
  16. Adam Bennett & Eduardo Borensztein & Tomás J. T. Baliño, 1999. "Monetary Policy in Dollarized Economies," IMF Occasional Papers 171, International Monetary Fund.
  17. Stephen M. Goldfeld, 1976. "The Case of the Missing Money," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(3), pages 683-740.
  18. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(2), pages 221-235, April.
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