This paper compares the impact of real shocks on small open economies operating under two opposite corner solutions: flexible exchange rates and official dollarization. Using an asymmetric two-country model of policy coordination, we show that although a pegged regime like dollarization is an effective device to achieve price stability, small open economies might be better off under a flexible exchange rate regime than under dollarization following any symmetric or asymmetric real shock. We also consider the claim that many small economies have only a limited ability to use their own monetary policy effectively and contrast the dollarization regime with one in which a small open economy follows "fear of floating" practices. In this case, we observe that unless its size is trivial, maintaining monetary policy sovereignty--even if it is not fully exploited--allows the domestic economy to experience lower losses from stabilization in the face of symmetric shocks. Only when an economy is negligibly small, are the costs of stabilization following "fear of floating" practices the same as those under dollarization.
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Paper provided by Department of Economics, University of York in its series Discussion Papers with number
05/27.
Length: Date of creation: Date of revision: Handle: RePEc:yor:yorken:05/27
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Find related papers by JEL classification: E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination F15 - International Economics - - Trade - - - Economic Integration
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Reinhart, Carmen & Calvo, Guillermo, 2002.
"Fear of floating,"
MPRA Paper
14000, University Library of Munich, Germany.
[Downloadable!]
Guillermo A. Calvo & Carmen M. Reinhart, 2000.
"Fear of Floating,"
NBER Working Papers
7993, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Alberto Alesina & Robert J. Barro, 2001.
"Dollarization,"
American Economic Review,
American Economic Association, vol. 91(2), pages 381-385, May.
[Downloadable!] (restricted)
Guillermo A. Calvo, 2002.
"On dollarization,"
The Economics of Transition,
The European Bank for Reconstruction and Development, vol. 10(2), pages 393-403, July.
[Downloadable!] (restricted)