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Dollarization, Bailouts, and the Stability of the Banking System

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  • Gale, Douglas
  • Vives, Xavier

Abstract

Central bank policy suffers from time-inconsistency when facing a banking crisis: A bailout is optimal ex post but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is good when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. However, a very severe moral hazard problem could make dollarization Undesirable. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR.

Suggested Citation

  • Gale, Douglas & Vives, Xavier, 2002. "Dollarization, Bailouts, and the Stability of the Banking System," Discussion Paper Series 26195, Hamburg Institute of International Economics.
    • Handle: RePEc:ags:hwwadp:26195
    DOI: 10.22004/ag.econ.26195
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    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F30 - International Economics - - International Finance - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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