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On the Benefits of Dollarization when Stabilization Policy is not Credible and Financial Markets are Imperfect

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Enrique G. Mendoza

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Abstract

This paper examines two potential benefits that emerging economies may derive from dollarization. First, dollarization may eliminate distortions induced by the lack of credibility of monetary policy. Second, dollarization may weaken financial frictions that result in endogenous credit constraints. The analysis is based on numerical simulations of a two-sector dynamic, stochastic general equilibrium model calibrated to Mexican data. The results indicate that policy uncertainty and credit constraints are very costly distortions. The mean welfare gains of eliminating policy uncertainty range between 6.4 and 9 percent of the trend level of consumption per capita. The mean welfare gain of weakening credit frictions is about 4.6 percent.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7824.

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Date of creation: Aug 2000
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Handle: RePEc:nbr:nberwo:7824

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Find related papers by JEL classification:
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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  1. Aysan, Ahmet Faruk, 2006. "The Role of Distribution of the Income Shares of Individuals in Tradables and Nontradables on Exchange Rate Fluctuations and Delay of Stabilizations," MPRA Paper 5485, University Library of Munich, Germany. [Downloadable!]
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  2. Araújo, Aloísio Pessoa de & Leon, Márcia Saraiva, 2002. "Speculative Attacks on Debts, Dollarization and Optimum Currency Areas," Economics Working Papers (Ensaios Economicos da EPGE) 446, Graduate School of Economics, Getulio Vargas Foundation (Brazil). [Downloadable!]
  3. 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. [Downloadable!]
  4. Roger Craine, 2001. "Dollarization: An Irreversible Decision," Department of Economics, Working Paper Series 1014, Department of Economics, Institute for Business and Economic Research, UC Berkeley. [Downloadable!]
  5. Aysan, Ahmet Faruk, 2006. "Distributional Effects of Boom-Bust Cycles in Developing Countries with Financial Frictions," MPRA Paper 5484, University Library of Munich, Germany. [Downloadable!]
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  6. Roger Craine, 2001. "Dollarization: An Irreversible Decision," International Finance 0103003, EconWPA. [Downloadable!]
  7. Michael Kumhof, 2001. "A Critical View of Inflation Targeting: Crises, Limited Sustainability, and Aggregate Shocks," Working Papers Central Bank of Chile 127, Central Bank of Chile. [Downloadable!]
    Other versions:
  8. 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. [Downloadable!] (restricted)
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