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The Effects of Dollarization on Macroeconomic Stability


  • Christopher J. Erceg and Andrew T. Levin


Recently, several countries have been considered the relative merits of "dollarization", that is, adopting the currency of an anchor country. One of the main potential costs of dollarization is that macroeconomic stability may be reduced by the loss of monetary policy autonomy. In this paper, we formlate a two-country open economy model with optimizing agents and nominal wage and price inertia. Using this model, we consider the extent to which the stabilization costs of dollarization are affected by the relative variability of foreign and domestic productivity and government spending shocks. We also consider the influence of certain key structural characteristics such as the relative size of the tradeable and non-tradeable sectors and the elasticity of foreign demand for domestically- produced tradeable goods. In light of these results, we evaluate the stabilization costs associated with dollarization for each of the 14 developing country blocks of the FRB/Global macroeconometric model.

Suggested Citation

  • Christopher J. Erceg and Andrew T. Levin, 2001. "The Effects of Dollarization on Macroeconomic Stability," Computing in Economics and Finance 2001 17, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:17

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    References listed on IDEAS

    1. Powell, Alan A., 2000. "From Dornbusch to Murphy: Stylized Monetary Dynamics of a Contemporary Macroeconometric Model," Journal of Policy Modeling, Elsevier, vol. 22(1), pages 99-116, January.
    2. Orphanides, Athanasios & Wieland, Volker, 2000. "Inflation zone targeting," European Economic Review, Elsevier, vol. 44(7), pages 1351-1387, June.
    3. Mercado, P. Ruben & Kendrick, David A., 2000. "Caution in macroeconomic policy: uncertainty and the relative intensity of policy," Economics Letters, Elsevier, vol. 68(1), pages 37-41, July.
    4. Neck, Reinhard & Matulka, Josef, 1994. "Stochastic optimum control of macroeconometric models using the algorithm OPTCON," European Journal of Operational Research, Elsevier, vol. 73(2), pages 384-405, March.
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    Cited by:

    1. Kollmann, Robert, 2002. "Monetary policy rules in the open economy: effects on welfare and business cycles," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 989-1015, July.

    More about this item


    monetary policy; currency unions; exchange rate regimes;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics


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