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The benefits of dollarization when stabilization policy lacks credibility and financial markets are imperfect


  • Enrique G. Mendoza


Dollarization entails two potentially large benefits for emerging economies. First, it may eliminate price and wealth distortions induced by the lack of credibility of stabilization policies. Second, it may improve the efficiency of financial markets by weakening informational or institutional frictions driving credit constraints. Quantitative analysis of a dynamic, stochastic equilibrium model calibrated to Mexican data shows that the mean welfare gains of eliminating policy uncertainty are staggering, ranging between 6.4 and 9 percent of trend consumption. The mean welfare gain of weakening credit constraints is 4.6 percent. Liability dollarization and sharp fluctuations in relative prices play a key role in these results.
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  • Enrique G. Mendoza, 2001. "The benefits of dollarization when stabilization policy lacks credibility and financial markets are imperfect," Proceedings, Federal Reserve Bank of Cleveland, pages 440-481.
  • Handle: RePEc:fip:fedcpr:y:2001:p:440-481

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    Cited by:

    1. Roc Armenter & Martin Bodenstein, 2005. "Does the time inconsistency problem make flexible exchange rates look worse than you think?," Staff Reports 230, Federal Reserve Bank of New York.
    2. Cristina Arellano & Enrique Mendoza, 2002. "Fricciones crediticias y 'paradas repentinas' en pequeñas economías abiertas: un marco de equilibrio del ciclo económico para crisis en mercados emergentes," Research Department Publications 4308, Inter-American Development Bank, Research Department.
    3. Francisco Venegas-Martinez & Ambrosio Ortiz-Ramírez & Francisco Ortiz-Arango, 2012. "Temporary stabilization: a Fréchet-Weibullextreme value distribution approach," EconoQuantum, Revista de Economia y Negocios, Universidad de Guadalajara, Centro Universitario de Ciencias Economico Administrativas, Departamento de Metodos Cuantitativos y Maestria en Economia., vol. 9(1), pages 35-55, Enero-Jun.
    4. Alexis Cruz-Rodriguez, 2013. "Choosing and Assessing Exchange Rate Regimes: a Survey of the Literature," Revista de Analisis Economico – Economic Analysis Review, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines, vol. 28(2), pages 37-61, October.
    5. Leduc, Sylvain, 2002. "Incomplete markets, borrowing constraints, and the foreign exchange risk premium," Journal of International Money and Finance, Elsevier, vol. 21(7), pages 957-980, December.
    6. Li, Shuyun May & Dressler, Scott, 2011. "Business cycle asymmetry via occasionally binding international borrowing constraints," Journal of Macroeconomics, Elsevier, vol. 33(1), pages 33-41, March.
    7. Krzysztof Makarski, 2014. "Dollarization as a signaling device," Bank i Kredyt, Narodowy Bank Polski, vol. 45(1), pages 17-36.
    8. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
    9. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers.
    10. Cristina Arellano & Enrique G. Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," NBER Working Papers 8880, National Bureau of Economic Research, Inc.
    11. Anton Korinek, 2011. "Hot Money and Serial Financial Crises," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 306-339, June.
    12. Michael Kumhof, 2002. "A Critical View of Inflation Targeting: Crises, Limited Sustaintability, and Aggregate Shocks," Central Banking, Analysis, and Economic Policies Book Series,in: Norman Loayza & Raimundo Soto & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.), Inflation Targeting: Desing, Performance, Challenges, edition 1, volume 5, chapter 8, pages 349-394 Central Bank of Chile.
    13. Norbert Fiess & Rashmi Shankar, 2005. "Regime-Switching in Exchange Rate Policy and Balance Sheet Effects," Working Papers 2005_16, Business School - Economics, University of Glasgow.
    14. Arellano, Cristina & Heathcote, Jonathan, 2010. "Dollarization and financial integration," Journal of Economic Theory, Elsevier, vol. 145(3), pages 944-973, May.
    15. Shimotsu, Tor, 2002. "Small Open Economy Model with Domestic Resource Shocks: Monetary Union vs. Floating Exchange Rate," Economics Discussion Papers 8841, University of Essex, Department of Economics.
    16. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
    17. Artus P., 2001. "What Exchange - Rate System For Emerging Countries?," European Research Studies Journal, European Research Studies Journal, vol. 0(1-2), pages 27-60, January -.
    18. Ravikumar, B & Wallace, Neil, 2002. "A benefit of uniform currency," MPRA Paper 22951, University Library of Munich, Germany.
    19. Fabio Ghironi & Alessandro Rebucci, 2000. "Monetary Rules for Emerging Market Economies," Boston College Working Papers in Economics 476, Boston College Department of Economics, revised 13 Aug 2001.
    20. Fabio Canova, 2005. "The transmission of US shocks to Latin America," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(2), pages 229-251.
    21. Michael B. Devereux, 2001. "Financial Constraints and Exchange Rate Flexibility in Emerging Market Economies," Working Papers 152001, Hong Kong Institute for Monetary Research.
    22. Choi, Woon Gyu & Cook, David, 2004. "Liability dollarization and the bank balance sheet channel," Journal of International Economics, Elsevier, vol. 64(2), pages 247-275, December.
    23. Marques, Luis B, 2007. "The Costs to Consumers of a Depreciated Conversion Rate to the Euro," MPRA Paper 5723, University Library of Munich, Germany.
    24. Lange, Carsten & Sauer, Christine, 2005. "Dollarization in Latin America: seigniorage costs and policy implications," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(4-5), pages 662-679, September.
    25. Gaetano Antinolfi & Todd Keister, 2001. "Dollarization as a monetary arrangement for emerging market economies," Review, Federal Reserve Bank of St. Louis, issue Nov., pages 29-40.

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