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Exploring the Implications of Official Dollarization on Macroeconomic Volatility

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Roberto Duncan

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Abstract

With a few exceptions, the advantages of dollarization have not been discussed in a dynamic general equilibrium framework, especially for partially dollarized economies that are supposed to be good candidates to follow this kind of regime. After reviewing the arguments for and against dollarization, this paper explores its implications on the volatility of the main macroeconomic variables of an emerging small open economy that faces terms-of-trade shocks. Dynamic equilibrium models are used as laboratories to study these issues and contrast two environments: a partially dollarized economy with flexible exchange rate (calibrated for the Peruvian economy) and a fully dollarized economy. Simulation exercises are performed to analyze in both cases the volatility of key variables such as output, consumption, investment, inflation rate, and fiscal deficit. The conclusions are that full dollarization implies (1) higher real volatility, especially on output and investment; (2) lower inflation volatility; (3) higher fiscal deficit volatility; (4) higher output response to terms-of-trade shocks. Consequently, in this context it is difficult to affirm that dollarization reduces country risk. Finally, the paper points up the role of price stickiness and countercyclical monetary policy in these findings.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 200.

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Date of creation: Feb 2003
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Handle: RePEc:chb:bcchwp:200

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  4. Ilan Goldfajn & Gino Olivares, 2000. "Is adopting Full Dollarization the solution? Looking at the evidence," Textos para discussão 416, Department of Economics PUC-Rio (Brazil). [Downloadable!]
  5. Bastourre, Diego & Carrera, Jorge & Féliz, Mariano & Panigo, Demian, 2003. "Dollarization and real volatility," CEPREMAP Working Papers (Couverture Orange) 0311, CEPREMAP. [Downloadable!]
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  8. Pereyra, Carlos & Quispe, Zenón, 2002. "¿Es conveniente una dolarización total en una economía parcialmente dolarizada?," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 8, pages 25-47. [Downloadable!]
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  17. Aaron Drew & Viv Hall & John McDermott & Robert St. Clair, 2001. "Would adopting the Australian dollar provide superior monetary policy in New Zealand?," Reserve Bank of New Zealand Discussion Paper Series DP2001/03, Reserve Bank of New Zealand. [Downloadable!]
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  18. Ben S. Bernanke & Refet S. Gurkaynak, 2001. "Is Growth Exogenous? Taking Mankiw, Romer and Weil Seriously," NBER Working Papers 8365, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. Michael W. Klein, 2002. "Dollarization and Trade," NBER Working Papers 8879, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January. [Downloadable!] (restricted)
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  1. Marcelo Ochoa & Patricio Valenzuela, 2004. "Impactos de un Shock Externo en un Modelo Estocástico de Equilibrio General para una Economía Abierta: El Caso de Chile," Macroeconomics 0407007, EconWPA. [Downloadable!]
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