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Revisiting the Concept of Dollarization; The Global Financial Crisis and Dollarization in Low-Income Countries

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  • Nkunde Mwase
  • Francis Y Kumah

Abstract

The economic literature has examined deposit dollarization in nominal terms, typically focusing on the ratio of foreign currency deposits to broad money. However, while private agent demand for foreign currency may remain unchanged in foreign currency terms, there could be large fluctuations in the dollarization ratio simply due to exchange rate movements. This paper proposes a new approach to measuring dollarization that removes these exchange rate effects, and demonstrates that beyond the variance of inflation and depreciation, the level of inflation and size of depreciation also matter for dollarization. While dollarization in nominal terms surged during the recent global financial crisis, there was a downward trend in real terms. Employing a set of econometric estimators, this paper investigates whether “real” dollarization during 2006–09 was associated with the crisis, and the role of initial macroeconomic conditions, quality of institutions, risk aversion, and prudential measures. We find that exchange rate appreciation and reductions in sovereign risk do moderate dollarization; but the results for global volatility have low statistical significance, perhaps because global shocks tend to preserve, to a large extent, relative attractiveness of foreign assets. Nonetheless, estimated impulse-response functions point to a large but short-lived positive impact of global volatility on dollarization, which could reflect economic agents heightened concerns about spillover effects of global uncertainty on the domestic economy.

Suggested Citation

  • Nkunde Mwase & Francis Y Kumah, 2015. "Revisiting the Concept of Dollarization; The Global Financial Crisis and Dollarization in Low-Income Countries," IMF Working Papers 15/12, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:15/12
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    References listed on IDEAS

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    1. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-625, June.
    2. Basso, Henrique S. & Calvo-Gonzalez, Oscar & Jurgilas, Marius, 2011. "Financial dollarization: The role of foreign-owned banks and interest rates," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 794-806, April.
    3. Honig, Adam, 2009. "Dollarization, exchange rate regimes and government quality," Journal of International Money and Finance, Elsevier, vol. 28(2), pages 198-214, March.
    4. Antonio Doblas-Madrid, 2009. "Fiscal Trends and Self-Fulfilling Crises," Review of International Economics, Wiley Blackwell, vol. 17(1), pages 187-204, February.
    5. Nicola Cetorelli & Linda S. Goldberg, 2009. "Globalized banks: lending to emerging markets in the crisis," Staff Reports 377, Federal Reserve Bank of New York.
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    Cited by:

    1. repec:rbp:esteco:ree-33-03 is not listed on IDEAS
    2. Sami Ben Naceur & Amr Hosny & Gregory Hadjian, 2015. "How to De-Dollarize Financial Systems in the Caucasus and Central Asia?," IMF Working Papers 15/203, International Monetary Fund.
    3. Alex Contreras & Zenón Quispe & Fernando Regalado, 2017. "Real dollarization and monetary policy in Peru," IFC Bulletins chapters,in: Bank for International Settlements (ed.), Statistical implications of the new financial landscape, volume 43 Bank for International Settlements.
    4. International Monetary Fund, 2015. "Angola; Selected Issues," IMF Staff Country Reports 15/302, International Monetary Fund.

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