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An open economy model with currency substitution and real dollarization

Author

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  • Germana Corrado

Abstract

Purpose - The paper aims at developing a theoretical model for Design/methodology/approach - The analysis is performed in a general equilibrium “New Open Economy Macroeconomics” framework with nominal rigidities and imperfect competition in the nontraded good sector. Findings - The paper finds that a dollar-indexed economy with low degrees of payments/financial dollarization could experience higher costs in terms of exchange rate and output fluctuations when nominal shocks dominate real shocks, making stabilization programs more difficult to achieve in a rapid and less costly way. Practical implications - The speed of adjustment of macro variables is faster in the highly dollarized economy as a response to a higher and more volatile inflation rate. A higher level of financial dollarization increases the frequency of domestic prices and wages revisions to nominal exchange rate shocks. This might explain, in turn, why nominal disturbances are shorter lived in the higher dollarized economies, and the asymmetry between financial and real dollarization Originality/value - Contrary to the “conventional wisdom” that predicts a positive relationship between the degrees of dollarization and the exchange rate pass-through, our model shows that the degree of dollarization and the degree of dollar indexation are not necessarily the same or even correlated.

Suggested Citation

  • Germana Corrado, 2008. "An open economy model with currency substitution and real dollarization," Journal of Economic Studies, Emerald Group Publishing, vol. 35(1), pages 69-93, January.
  • Handle: RePEc:eme:jespps:v:35:y:2008:i:1:p:69-93
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    Citations

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    Cited by:

    1. Yinusa, D. Olalekan, 2009. "Macroeconomic Fluctuations and Deposit Dollarization in Sub-Saharan Africa: Evidence from Panel Data," MPRA Paper 16259, University Library of Munich, Germany, revised 2009.
    2. Adeniji, Sesan, 2013. "Investigating the Relationship between Currency Substitution, Exchange Rate and Inflation in Nigeria: An Autoregressive Distributed Lag (ARDL) Approach," MPRA Paper 52551, University Library of Munich, Germany, revised 28 Dec 2013.
    3. Yinusa, D. Olalekan, 2008. "Exchange Rate Volatility, Currency Substitution and Monetary Policy in Nigeria," MPRA Paper 16255, University Library of Munich, Germany.
    4. Lula G. Mengesha & Mark J. Holmes, 2013. "Does Dollarization Alleviate Or Aggravate Exchange Rate Volatility?," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(2), pages 99-118, June.

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