An Evaluation of Monetary Regime Options for Latin America

Over the past decade, most Latin American countries have moved toward either extreme of floating rates or dollarization, in line with worldwide trends. In this paper, we evaluate the wisdom of those decisions and the choice of monetary regime more generally. We first evaluate the desirability of adopting a common currency in the region. We find that, under present circumstances, the costs of a common currency are likely to outweigh its benefits, as these countries do not trade much with each other and, moreover, they face diverse economic shocks, their business cycles are not coordinated, and they are affected by common shocks to sentiment in international financial markets only to the same extent than the average pair of emerging markets. We next consider the unilateral dollarization option. For most Latin American countries, this would be desirable only when there are strong links to the US economy, the credibility of the monetary authorities is irreversibly lost, and there is a keen demand for dollar-denominated financial assets. Finally, we review the relatively short experience of floating exchange regimes in Latin America and find that, despite the external constraints, floating countries have retained sufficient flexibility to use monetary policy for domestic ends in response to important shocks.