On the Benefits of Dollarization when Stabilization Policy Is Not Credible and Financial Markets are Imperfect
This paper argues that dollarization can be beneficial for countries where credit-market frictions and non-credible stabilization policies are large distortions on economic activity and welfare. A dynamic general-equilibrium model with these features is proposed for the case of a small open economy with a non-credible managed exchange-rate regime and a liquidity requirement that acts as an endogenous borrowing constraint. Assessing the experience of Mexico in the light of the quantitative predictions of this model suggests that, unless mechanisms to secure potential benefits of discretionary monetary policy can be implemented, dollarization is worth pursuing. The mean welfare gain of neutralizing both credibility distortions and credit frictions exceeds 9 percent in terms of the trend level of consumption per capita.
|Date of creation:||2000|
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