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Exhange Rate Volatility and Productivity Growth : The Role of Liability Dollarization

  • Kenza Benhima

    (Crest)

The contribution of this study is to show how liability dollarization conditions the effectof exchange rate volatility on growth. To illustrate this point, the paper lays down a model in whichcredit constrained firms face liquidity shocks denominated in tradable goods while their revenues are bothin tradable and nontradable goods. Under the assumptions that the production of nontradable goodsis labor-intensive, that nominal wages are preset and that the elasticity of substitution between goodsis lower than one, a fixed exchange rate is growth enhancing in countries whose debt is denominated interms of foreign currency (complete dollarization) because it stabilizes firms’ cash flows. However, incountries where a fraction of the debt is denominated in domestic currency (partial dollarization), thedifference between the growth performance of fixed and flexible exchange rate regimes can disappearsince the debt structure can help firms hedge their cash-flow risk under floating regimes. The theoreticalresults are backed by an empirical analysis on a panel of 77 countries spanning the years 1995-2004. Itappears that the higher the degree of liability dollarization, the more negative the impact of exchangerate flexibility on growth.

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Paper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 2008-11.

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Length: 40
Date of creation: 2008
Handle: RePEc:crs:wpaper:2008-11
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