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Dollarization and financial integration

  • Arellano, Cristina
  • Heathcote, Jonathan

How does a country's exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government responds to shocks by adjusting monetary policy and foreign borrowing. Sovereign borrowing is subject to endogenous limits, which ensure repayment when the default punishment corresponds to financial autarky. Dollarizing implies renouncing monetary policy, but can make access to international debt markets more valuable, thereby loosening borrowing constraints. This mechanism linking dollarization to financial integration is consistent with observed declines in spreads on foreign-currency debt in countries adopting the dollar or the euro.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 145 (2010)
Issue (Month): 3 (May)
Pages: 944-973

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Handle: RePEc:eee:jetheo:v:145:y:2010:i:3:p:944-973
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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