The Dollarization Debate

By Dominick Salvatore; James W. Dean et al. | Go to book overview

fiscal performance than nondollarizers. How did they manage to be equally “irresponsible” on the fiscal side and yet maintain their monetary regime and have very low rates of inflation? The answer to this query comes in two parts. First, the record shows that not all the dollarized countries maintained the system. For instance, when the fiscal constraint became too tight, Liberia abandoned dollarization. It is true that this development took place in the midst of a civil conflict, but political upheaval is a reality of life among the poorer nations. Second, and as shown in the third section, Panama has been able to run large fiscal deficits by accumulating a large stock of debt—that it occasionally restructured—and by maintaining a very special relationship with the IMF. It is not obvious that the IMF will be so friendly to future dollarizers that do not have Panama's geopolitical importance.

It is important to clarify what this study does not say. It does not say that dollarization is a policy option that all emerging markets should avoid. It does say, however, that empirically we know very little about the costs and benefits of dollarization. It further says that when the limited record is investigated, it does not appear to be as positive as some analysts want us to believe. In that regard, the recent experiences of Ecuador and El Salvador should provide important information that will help us assess more fully the merits of dollarization in larger and somewhat more complex settings.

Overall, Mundell's (1961) OCAs analysis continues to be the right approach for dealing with the dollarization question. There are good reasons to think that countries that are highly integrated in terms of factor mobility and trade will benefit from having a common currency. 21 The benefits from such a policy could more than compensate for the costs, including the loss of seignorage if the country dollarizes unilaterally. Countries with a high degree of unofficial dollarization and foreign currency–denominated liabilities are also likely to benefit from dollarization. It is unlikely, however, that dollarization will be the most adequate option for all countries. Large countries that face volatile terms of trade, that are not deeply integrated to major economies, and whose financial sector operate mostly in terms of domestic currency are likely to incur net costs if they dollarize. They will have difficulties in accommodating external shocks while, as suggested by the results in this article, the alleged benefits in terms of low costs of capital, fiscal discipline, and stability may, indeed, continue to be elusive.


Ithank Igal Magendzo for his assistance. Ihave benefited from discussions with John Cochrane and Ed Leamer.

Sometimes this policy is called “official dollarization” as a way of distinguishing it from currency substitution, or “unofficial dollarization.” See Savastano (1992).
Recent articles by Moreno-Villalaz (1999) and Bogetic (2000) discuss some im-


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The Dollarization Debate
Table of contents

Table of contents

  • Title Page *
  • Preface v
  • Contents vii
  • Contributors ix
  • The Dollarization Debate *
  • Introduction 3
  • I - General Analysis 15
  • A Visionary's View 17
  • 1 - Currency Areas, Exchange Rate Systems, and International Monetary Reform 17
  • Notes 43
  • References 45
  • De Facto Dollarization 46
  • 2 - Currency Substitution, Network Externalities, and Irreversibility 46
  • Notes 69
  • References 70
  • Pros and Cons 72
  • 3 - The Pros and Cons of Full Dollarization 72
  • Notes 98
  • References 99
  • 4 - Is It Time for a Common Currency for the Americas? 102
  • Notes 108
  • References 109
  • 5 - Myths and Realities 111
  • Notes 125
  • References 127
  • 6 - What Problems Can Dollarization Solve? 129
  • Notes 136
  • References 138
  • 7 - What Use Is Monetary Sovereignty? 140
  • Notes 151
  • References 151
  • One Regime for All Countries? 154
  • 8 - Thomas D. Willett 154
  • Notes 166
  • References 168
  • 9 - Dollarization Does Not Make Sense Everywhere 172
  • Notes 176
  • 10 - The Problem of Dollar Encroachment in Emerging Markets 177
  • Notes *
  • References *
  • 11 - Which Countries in the Americas Should Dollarize? 196
  • References *
  • 12 - Are the Currencies of Financially Small Countries on the Endangered List? 206
  • References 216
  • II - Political Economy 221
  • 13 - The Political Dimension 221
  • Note 236
  • References 236
  • 14 - Political Economy Aspects 238
  • Notes 256
  • References 260
  • 15 - The Political Economy of Dollarization in Mexico 266
  • Notes 279
  • References 281
  • 16 - Analytic and Political Economy Perspectives 283
  • Notes 293
  • References 294
  • III - North America 297
  • 17 - A Canadian Perspective 299
  • Note 316
  • References 316
  • 18 - The Merit of a North American Monetary Union 318
  • Notes 336
  • References 338
  • 19 - Why Canada Needs a Flexible Exchange Rate 341
  • Notes 359
  • References 361
  • IV - Latin America 363
  • 20 - Should Latin America's Common-Law Marriage to the U.S. Dollar Be Legalized? Should Canada's? 365
  • Notes 372
  • References 374
  • 21 - What Exchange Rate Arrangement Works Best for Latin America? 375
  • Notes 385
  • References 386
  • 22 - A Dollarization/free-Banking Blueprint for Argentina 387
  • Notes 399
  • References 399
  • 23 - Argentina's Currency Board and the Case for Macroeconomic Policy Coordination in Mercosur 401
  • Notes 422
  • References 423
  • 24 - Dollarization and Dedollarization 425
  • Notes 446
  • References 447
  • Index 449


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