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Twin dollarization and exchange rate policy

  • Shi, Kang
  • Xu, Juanyi

This paper develops a small open economy general equilibrium model with nominal rigidities to study twin dollarization in East Asian economies, a phenomenon where firms borrow in US dollars and also set export prices in US dollars. In this model, we endogenize both the currency of liability denomination and the currency of export pricing. We show that a key factor that affects firms' dollarization decisions is exchange rate policy. Twin dollarization is an optimal strategy for all firms when exchange rate flexibility is limited, which implies that a fixed exchange rate regime may lead to an equilibrium with twin dollarization. Furthermore, we find that twin dollarization can reduce the welfare loss caused by the fixed exchange rate regime, as it helps to cushion the economy against domestic nominal risk.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 81 (2010)
Issue (Month): 1 (May)
Pages: 109-121

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Handle: RePEc:eee:inecon:v:81:y:2010:i:1:p:109-121
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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  1. Devereux, Michael B & Engel, Charles M & Storgaard, Peter Ejler, 2002. "Endogenous Exchange Rate Pass-Through When Nominal Prices Are Set in Advance," CEPR Discussion Papers 3608, C.E.P.R. Discussion Papers.
  2. Chang, Roberto & Velasco, Andres, 2006. "Currency mismatches and monetary policy: A tale of two equilibria," Journal of International Economics, Elsevier, vol. 69(1), pages 150-175, June.
  3. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," CEPR Discussion Papers 2963, C.E.P.R. Discussion Papers.
  4. Charles Engel, 2006. "Equivalence Results for Optimal Pass-Through, Optimal Indexing to Exchange Rates, and Optimal Choice of Currency for Export Pricing," Journal of the European Economic Association, MIT Press, vol. 4(6), pages 1249-1260, December.
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  12. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," IDB Publications (Working Papers) 6467, Inter-American Development Bank.
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  17. Devereux, Michael B. & Shi, Kang & Xu, Juanyi, 2007. "Global monetary policy under a dollar standard," Journal of International Economics, Elsevier, vol. 71(1), pages 113-132, March.
  18. Shin-ichi Fukuda & Masanori Ono, 2004. "The Choice of Invoice Currency under Uncertainty: Theory and Evidence from Korea," CIRJE F-Series CIRJE-F-271, CIRJE, Faculty of Economics, University of Tokyo.
  19. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373.
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