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Dollarization: A Dead End

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  • Alex Izurieta

Abstract

When economies "dollarize," their exchange rate and monetary policy, both considered to be sources of instability, are simultaneously discarded. Often, dollarization becomes an attractive option for developing countries that have experienced successive failures of exchange rate and monetary management. This paper makes use of a theoretical model that shows, contrary to the commonly accepted view, that a dollarized economy would experience financial instability in the event of external shocks should it attempt to operate discretionary fiscal policies. Shocks not simultaneously contained by adjustments to spending would lead to ever-increasing fiscal and current account deficits because public sector borrowing requirements can only be financed by selling bonds in the open market at constantly rising rates of interest. Hence, such a path cannot be an option. Alternatively, if fiscal spending were curbed at par with the shock, external and current account balances would converge to equilibrium, but trigger a recession and increased unemployment. Since this, too, is unacceptable, dollarization turns out to be a "dead end."

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  • Alex Izurieta, 2002. "Dollarization: A Dead End," Economics Working Paper Archive wp_344, Levy Economics Institute.
  • Handle: RePEc:lev:wrkpap:wp_344
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    References listed on IDEAS

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    1. Hyman P. Minsky, 1989. "Financial Structures: Indebtedness and Credit," Palgrave Macmillan Books, in: Alain Barrère (ed.), Money, Credit and Prices in Keynesian Perspective, chapter 3, pages 49-70, Palgrave Macmillan.
    2. Roe, Alan R, 1973. "The Case for Flow of Funds and National Balance Sheet Accounts," Economic Journal, Royal Economic Society, vol. 83(330), pages 399-420, June.
    3. repec:bla:revinw:v:19:y:1973:i:2:p:143-66 is not listed on IDEAS
    4. Richard Stone, 1973. "A System Of Social Matrices," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 19(2), pages 143-166, June.
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    Cited by:

    1. Rivera-Solis, Luis Eduardo, 2012. "Dollarization in El Salvador: Revisited," MPRA Paper 60087, University Library of Munich, Germany, revised Jan 2012.

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