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Dominant Currency Paradigm: Financial Dollarization View

Author

Listed:
  • Tamta Sopromadze

    (Macroeconomic Research Division, National Bank of Georgia)

  • Giorgi Barbakadze

    (Advisor, International Monetary Fund)

  • Shalva Mkhatrishvili

    (Head of Macroeconomics and Statistics Department, National Bank of Georgia)

Abstract

This paper proposes an alternative view for the dominant currency paradigm. More specifically, the role of financial dollarization in exchange rate pass-through is analyzed. In highly dollarized countries, where domestic producers are unhedged, exchange rate depreciations against a dominant currency create additional pressures on inflation. In particular, depreciation increases unhedged borrowers’ debt-service costs, which then push overall prices up. We use a panel of countries with highly dollarized economies to empirically estimate the impact of dominant currency exchange rates on inflation. On the theoretical front, we demonstrate this channel by a simple dynamic stochastic general equilibrium (DSGE) model to show how liability dollarization of domestic producers may change the optimal monetary policy reaction to USD exchange rate movements globally. These results provide an interesting insight for monetary policymakers, especially for countries with small open economies that are exposed to external shocks. The implications can help gauge the optimal monetary policy response to the US monetary policy-induced exchange rate movements for countries that may even not trade much with the US but have high financial dollarization.

Suggested Citation

  • Tamta Sopromadze & Giorgi Barbakadze & Shalva Mkhatrishvili, 2021. "Dominant Currency Paradigm: Financial Dollarization View," NBG Working Papers 01/2021, National Bank of Georgia.
  • Handle: RePEc:aez:wpaper:2021-01
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    More about this item

    Keywords

    Dominant currency paradigm; Exchange rate pass-through; Dollarization; Monetary policy;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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