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Liquidity shocks and the dollarization of a banking system

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  • Machicado, Carlos Gustavo

Abstract

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.

Suggested Citation

  • Machicado, Carlos Gustavo, 2008. "Liquidity shocks and the dollarization of a banking system," Journal of Macroeconomics, Elsevier, vol. 30(1), pages 369-381, March.
  • Handle: RePEc:eee:jmacro:v:30:y:2008:i:1:p:369-381
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    Citations

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    Cited by:

    1. Alejandro Arrieta Herrera & Jorge Guillen Uyen, 2012. "Currency-Induced Credit Risk in a Dollarized Economy," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(5), pages 105-114, September.
    2. Andreev, M. & Pil'nik, N. & Pospelov, I., 2009. "Rational Expectation Model of Modern Russian Banking System and the Strong Turnpike Property," Journal of the New Economic Association, New Economic Association, issue 3-4, pages 72-96.
    3. Alejandro Arrieta Herrera & Jorge Guillen Uyen, 2012. "Currency-Induced Credit Risk in a Dollarized Economy," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., vol. 48(5), pages 105-114, September.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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