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Twin dollarization and exchange rate policy

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  • Shi, Kang
  • Xu, Juanyi

Abstract

This paper develops a small open economy general equilibrium model with nominal rigidities to study twin dollarization in East Asian economies, a phenomenon where firms borrow in US dollars and also set export prices in US dollars. In this model, we endogenize both the currency of liability denomination and the currency of export pricing. We show that a key factor that affects firms' dollarization decisions is exchange rate policy. Twin dollarization is an optimal strategy for all firms when exchange rate flexibility is limited, which implies that a fixed exchange rate regime may lead to an equilibrium with twin dollarization. Furthermore, we find that twin dollarization can reduce the welfare loss caused by the fixed exchange rate regime, as it helps to cushion the economy against domestic nominal risk.

Suggested Citation

  • Shi, Kang & Xu, Juanyi, 2010. "Twin dollarization and exchange rate policy," Journal of International Economics, Elsevier, vol. 81(1), pages 109-121, May.
    • Handle: RePEc:eee:inecon:v:81:y:2010:i:1:p:109-121
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    Cited by:

    1. Gong Liutang & Wang Chan & Zou Heng-Fu, 2020. "Optimal monetary policy in a model of vertical production and trade with reference currency," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(1), pages 1-21, January.
    2. Kang Shi & Juanyi Xu, 2008. "The Optimal Currency Basket with Input Currency and Output Currency," Working Papers 172008, Hong Kong Institute for Monetary Research.
    3. Xu, Juanyi, 2011. "The optimal currency basket under vertical trade," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1323-1340.
    4. Bengui, Julien & Nguyen, Ha, 2016. "Consumption baskets and currency choice in international borrowing," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 287-304.
    5. Chan Wang & Heng-fu Zou, 2015. "Optimal Monetary Policy Under a Global Dollar Standard: The Effect of Vertical Trade and Production," Open Economies Review, Springer, vol. 26(1), pages 121-137, February.
    6. Herman Kamil, 2012. "How Do Exchange Rate Regimes Affect Firms' Incentives to Hedge Currency Risk? Micro Evidence for Latin America," IMF Working Papers 2012/069, International Monetary Fund.
    7. Sheng Wang & Rufei Guo, 2016. "Asymmetric Exchange Rate Pass-through and Monetary Policy in Open Economy," Annals of Economics and Finance, Society for AEF, vol. 17(1), pages 33-53, May.
    8. Chan Wang & Heng-fu Zou, 2013. "Optimal monetary policy in open economies: the role of reference currency in vertical production and trade," CEMA Working Papers 586, China Economics and Management Academy, Central University of Finance and Economics.

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