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.