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Liquidity shocks and the dollarization of a banking system

  • Machicado, Carlos Gustavo

This paper shows how uncertainty about liquidity demand can lead to a high degree of dollarization in the banking system. I study a model where the demand for currency in each period is random, and where it is easier for banks to borrow in local currency in times of crisis than in dollars. Banks choose a portfolio composed of local currency, dollars, and real loans. Compared to the anticipated transactions demand for each currency, I show that the bank will hold a relatively large amount of dollars and a relatively small amount of local currency. I also show the existence of a dollarization multiplier: as the anticipated transactions demand for dollars increases, the dollarization of the banking sector increases more than proportionately.

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File URL: http://www.sciencedirect.com/science/article/pii/S0164-0704(07)00057-2
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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 30 (2008)
Issue (Month): 1 (March)
Pages: 369-381

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Handle: RePEc:eee:jmacro:v:30:y:2008:i:1:p:369-381
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622617

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  1. Antinolfi, Gaetano & Keister, Todd, 2006. "Discount Window Policy, Banking Crises, And Indeterminacy Of Equilibrium," Macroeconomic Dynamics, Cambridge University Press, vol. 10(01), pages 1-19, February.
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  3. Antinolfi, Gaetano & Huybens, Elisabeth & Keister, Todd, 2001. "Monetary Stability and Liquidity Crises: The Role of the Lender of Last Resort," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 187-219, July.
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  9. Martin Uribe, 1995. "Hysteresis in a simple model of currency substitution," International Finance Discussion Papers 509, Board of Governors of the Federal Reserve System (U.S.).
  10. Joseph H. Haslag & Antoine Martin, 2003. "Optimality of the Friedman rule in overlapping generations model with spatial separation," Research Working Paper RWP 03-03, Federal Reserve Bank of Kansas City.
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  12. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
  13. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  14. Townsend, Robert M, 1987. "Economic Organization with Limited Communication," American Economic Review, American Economic Association, vol. 77(5), pages 954-71, December.
  15. Bhattacharya, Joydeep & Haslag, Joseph & Russell, Steven, 2004. "The Role of Money in Two Alternative Models: When is the Friedman Rule Optimal, and Why?," Staff General Research Papers Archive 11950, Iowa State University, Department of Economics.
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  17. Bruce D. Smith, 2002. "Monetary Policy, Banking Crises, and the Friedman Rule," American Economic Review, American Economic Association, vol. 92(2), pages 128-134, May.
  18. Juan Antonio Morales Anaya, 2003. "Dollarization of assets and liabilities: Problem or solution?. The case of Bolivia," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 6(1), pages 7-39, June.
  19. Marco Terrones & Luis Catão, 2000. "Determinants of Dollarization; The Banking Side," IMF Working Papers 00/146, International Monetary Fund.
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