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Financial dollarization: evaluating the consequences
[‘A simple model of monetary policy and currency crises’]

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  • Eduardo Levy Yeyati

Abstract

The presence in residents’ portfolio of foreign-currency assets and liabilities (or ‘financial dollarization’) has been alleged to influence monetary policy in developing economies and, especially, to cause debtors’ insolvency in the aftermath exchange rate depreciations (the ‘balance sheet effect’). The abundant and influential literature on these implications, however, contrasts sharply with the scarcity of empirical work aimed at confirming or refuting them. Using a new database, this paper assesses the evidence on the determinants of financial dollarization and tests whether its empirical effects on monetary and financial stability and on economic performance are consistent with theoretical predictions. It finds that financially dollarized economies display a more unstable demand for money, a greater propensity to suffer banking crises after a depreciation of the local currency, and slower and more volatile output growth, without significant gains in terms of domestic financial depth. The results indicate that active de-dollarization policies may be advisable for the many economies, including Central and Eastern European ones, where foreign-currency denominated assets and liabilities are important in residents’ financial portfolios.— Eduardo Levy Yeyati

Suggested Citation

  • Eduardo Levy Yeyati, 2006. "Financial dollarization: evaluating the consequences [‘A simple model of monetary policy and currency crises’]," Economic Policy, CEPR;CES;MSH, vol. 21(45), pages 62-118.
  • Handle: RePEc:oup:ecpoli:v:21:y:2006:i:45:p:62-118.
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    File URL: http://hdl.handle.net/10.1111/j.1468-0327.2006.00154.x
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    2. Levy Yeyati, Eduardo & Sturzenegger, Federico & Reggio, Iliana, 2010. "On the endogeneity of exchange rate regimes," European Economic Review, Elsevier, vol. 54(5), pages 659-677, July.
    3. Aysen Arac & Funda Telatar & Erdinc Telatar, 2012. "Investigating the Time Varying Nature of the Link between Inflation and Currency Substitution in the Turkish Economy," Hacettepe University Department of Economics Working Papers 20122, Hacettepe University, Department of Economics.
    4. Barry Eichengreen, 2007. "Insurance Underwriter or Financial Development Fund: What Role for Reserve Pooling in Latin America?," Open Economies Review, Springer, vol. 18(1), pages 27-52, February.
    5. Aron Gereben & Ferenc Karvalits & Zalan Kocsis, 2011. "Monetary policy challenges during the crisis in a small open dollarised economy: the case of Hungary," BIS Papers chapters, in: Bank for International Settlements (ed.), Capital flows, commodity price movements and foreign exchange intervention, volume 57, pages 179-188, Bank for International Settlements.
    6. Paul Castillo & Juan Pablo Medina, 2021. "Foreign Exchange Intervention, Capital Flows, and Liability Dollarization," GRU Working Paper Series GRU_2021_027, City University of Hong Kong, Department of Economics and Finance, Global Research Unit, revised 25 Jul 2021.
    7. Juan Carlos Berganza & Alicia García-Herrero, 2004. "What makes balance sheet effects detrimental for the country risk premium?," Working Papers 0423, Banco de España.
    8. Bitar, Joseph, 2021. "Foreign Currency Intermediation: Systemic Risk and Macroprudential Regulation," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 2(2).
    9. Bitar, Joseph, 2021. "The unique dollarization case of Lebanon," Economic Systems, Elsevier, vol. 45(2).
    10. Kyriakos C. Neanidis & Christos S. Savva, 2020. "Cross-Border Spillovers in Foreign Currency Credit," Economics Discussion Paper Series 2002, Economics, The University of Manchester.
    11. Eduardo Levy Yeyati, 2004. "Dollars, Debt and the IFIs: Dedollarizing Multilateral Lending," Business School Working Papers dedollmultlending, Universidad Torcuato Di Tella.
    12. Paul Castillo & Juan Pablo Medina, 2021. "Foreign Exchange Intervention, Capital Flows, and Liability Dollarization," GRU Working Paper Series GRU_2021_027, City University of Hong Kong, Department of Economics and Finance, Global Research Unit, revised 25 Jul 2021.

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    More about this item

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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