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Persistence of dollarization after price stabilization

  • Rappoport, Veronica

Credit contracts in developing countries are often denominated in foreign currencies, even after many of these economies succeeded in controlling inflation. This paper proposes a new interpretation of this apparent puzzle based on the demand for insurance against real shocks: the fact that devaluations occur more frequently in adverse states of the world provides a motive for holding dollar assets. This approach implies a complementarity between the optimal monetary policy and the currency denomination of contracts. When a large proportion of liabilities is denominated in a foreign currency, the optimal exchange rate volatility is low, which reinforces the demand for dollar assets.

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File URL: http://www.sciencedirect.com/science/article/B6VBW-4X9TV03-1/2/006dda27ab8d68e28f88b9bc42fc5a3a
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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 56 (2009)
Issue (Month): 7 (October)
Pages: 979-989

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Handle: RePEc:eee:moneco:v:56:y:2009:i:7:p:979-989
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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