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Financial Dollarization and Debt Deflation under a Currency Board

  • Sebastian Galiani

    ()

    (Department of Economics, Universidad de San Andres)

  • Eduardo Levy Yeyati

    (Universidad Torcuato Di Tella)

  • Ernesto Schargrodsky

    (Universidad Torcuato Di Tella)

In the late currency board years, Argentina faced a real exchange rate adjustment through price deflation amidst growing devaluation expectations. Using a firm-level panel database to analyze the incidence of these factors on the currency composition of private debt and on firms’ performance, we find that widespread debt dollarization showed no relationship with the firms’ production mix or the ever-changing probability of a nominal devaluation. While relative price changes favored export-oriented firms with the expected impact on sales, earnings and investment, increases in devaluation expectations elicited only a marginal differential response in investment from more financially dollarized firms. Our findings provide support to two criticisms faced by the Argentine currency board in recent years, namely, that by fueling beliefs in an implicit guarantee it stimulated across-the-board debt dollarization, and that it could not fully isolate the economy from real shocks, as the feared balance sheet effect was replaced by a gradual but equally deleterious debt deflation effect.

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Paper provided by Universidad de San Andres, Departamento de Economia in its series Working Papers with number 64.

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Date of creation: Oct 2003
Date of revision: Nov 2003
Publication status: Published in Emerging Markets Review, Vol. 4, 2003, pages 340-367
Handle: RePEc:sad:wpaper:64
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