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Dollarization, bailouts, and the stability of the banking system

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  • Douglas Gale
  • Xavier Vives

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. We would never put ourselves in a position where we envisioned actions that we would take would be of assistance to the rest of the world but to the detriment of the United States. Alan Greenspan to a congressional panel in 1999 [IHT, January 19, 2000].
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Suggested Citation

  • Douglas Gale & Xavier Vives, 2001. "Dollarization, bailouts, and the stability of the banking system," Proceedings 729, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhpr:729
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Dollar; Banks and banking;

    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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