Indexation and Dollarization

“Index-linking,” strictly defined, is the use of purchasing power as a unit of account. Since a “price index” is the money price of a basket containing all goods and services in proportion to their relative importance in total output, in principle any value “linked” to the index remains constant in terms of such baskets. “Dollarization” may be defined as the use of the US dollar as a unit of account in an economy that has its own money unit.1 The dollar’s domestic-money value is the current exchange rate—usually the free-market rate if this differs from the “official” rate. The domestic-money value of anything whose value is given in dollars therefore rises whenever the domestic currency depreciates against the dollar. In what follows, save where specifically noted, the public is assumed to expect the currency to depreciate at a rate roughly equal to the inflation rate, so that the dollar amounts practically to a purchasing-power unit.