Dollarization and financial integration

How does a country's choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. ; We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union: in each case, around the time of regime change, spreads on foreign currency government debt declined substantially.Financial crises ; Foreign exchange administration

Currency Areas, Exchange Rate Systems and International Monetary Reform

I. Introduction II. The Pre-Eminence of the Dollar III. The Fate of the Gold Standard IV. Currency Areas and Currency Unions V. The Importance of Monetary Rules VI. Monetary Arrangements in Free Trade Areas and Customs Unions VII. Central Banks, Dollarization and the Maastricht Conditions VIII. Exchange Rate Volatility and Internal vs. External Stability IX. Towards a World Currencypower configuration; currency areas; monetary rules; financial integration; world currency

Zimbabwe: From Hyperinflation to Growth

The hallmark of Zimbabwe's economic collapse is hyperinflation. The most recent official inflation figure is for February 2008: a whopping 165,000 percent year-over-year. At present (early June 2008), inflation is unofficially about 2.5 million percent a year. Not surprisingly, the Zimbabwe dollar has lost more than 99.9 percent of its value against the U.S. dollar during the past year.Zimbabwe's hyperinflation is destroying the economy, pushing more of its inhabitants into poverty, and forcing millions of Zimbabweans to emigrate. Between 1997 and 2007, cumulative inflation was nearly 3.8 billion percent, while living standards fell by 38 percent. The source of Zimbabwe's hyperinflation is the Reserve Bank of Zimbabwe's money machine. The government spends, and the RBZ finances the spending by printing money. The RBZ has no ability in practice to resist the government's demands for cash. Accordingly, the RBZ cannot hope to regain credibility anytime soon. To stop hyperinflation, Zimbabwe needs to immediately adopt a different monetary system. Any one of three options can rapidly slash the inflation rate and restore stability and growth to the Zimbabwean economy. First is "dollarization." This option would replace the discredited Zimbabwe dollar with a foreign currency, such as the U.S. dollar or the South African rand. Second is a currency board. Under that system, the Zimbabwe dollar would be credible because it would be fully backed by a foreign reserve currency and would be freely convertible into the reserve currency at a fixed rate on demand. Third is free banking. This option would allow commercial banks to issue their own private notes and other liabilities with minimum government regulation. Central banking is the only monetary system that has ever created hyperinflation and instability in Zimbabwe. Prior to central banking, Zimbabwe had a rich monetary experience in which a free banking system and a currency board system performed well. It is time for Zimbabwe to adopt one of these proven monetary systems and discard its failed experiment with central banking

Currency Aspects of Financial Security of the Banking System of Ukraine: Regulatory Priorities and Transformation of Control

The article is devoted to the topical subject – the study of currency aspects of the financial security of the banking system of Ukraine, taking into account the threats of liberalization of cross-border capital transfer and currency regulation. The main objectives of the article are studying the main threats to the currency security of the banking system of Ukraine in the context of the transformation of currency control within the liberalization of currency relations. In particular, the study found that currency security is one of the main components of the financial security of the banking system, and exchange rate instability is one of the greatest threats to the effective functioning of Ukrainian banking institutions, taking into account the peculiarities of the national structure of financial assets and liabilities of business entities. As a result, it is found that the deterioration of the exchange rate stability leads to a revaluation of assets, the outflow of foreign currency deposits from banks, which leads to their loss and significant deterioration of financial security, while a decrease in the volume of gold and foreign exchange reserves directly affects the currency security of the state, in particular, and the economic in general. Based on the research results, proposals have been made to improve currency regulation and currency control, namely, amendments to the draft law should be made with regard to the administrative restriction of the dollarization level of deposits and credits, indicating the terms for reducing the dollarization rates of loans and deposits from 50 % to 20–25 %. The mechanism for such reduction in dollarization should be included in the instruments of the National Bank of Ukraine, namely, the norm of mandatory reservation for deposits in foreign currency should be 3–4 times higher than the reserve rate in the national currency, which will make foreign currency deposits "uninteresting" for banks, and therefore will lead to a reduction in the interest rate and, accordingly, reduce the desire to save in foreign currency. By dollarization of loans, the credit risk reservation ratio should also be significantly higher than in the national currency in order to demobilize banks for lending in foreign currency, an exception can only be for those enterprises that carry out foreign economic activity. In addition, lending to individuals for all types of loans in foreign currency should be banned, and the fact of such ban should be clearly spelled out in the Law on Currency. This will prevent the outflow of capital from the state and form a mechanism to reduce the scale of the shadow foreign exchange market as the main threats to the currency and financial security of the banking system of Ukraine

Dollarization as a monetary arrangement for emerging market economies

Official dollarization refers to the adoption of the U.S. dollar as legal tender in place of the national currency. Some Latin American countries have recently dollarized, and others have seriously considered dollarization. This article discusses the reasons behind the surge of interest in dollarization and provides a review of the new academic literature on the topic. It discusses in detail some of the factors that are commonly considered to be the important costs and benefits of dollarizing. The paper also provides an analysis of the existing liability dollarization in several countries and its relation with official dollarization. Finally, it briefly looks at dollarization from the perspective of the United States.Dollar ; Money ; Latin America

Cambodia's Persistent Dollarization: Causes and Policy Options

Cambodia's economic and social achievements over the past ten years have been the most impressive in its history. Nevertheless, Cambodia today is still as dollarized, if not more so, than it was ten years ago. What is this so, and what, if anything, should the Government do? This paper attempts to answer both these questions, by examining the reasons behind the apparent paradox between a decade of economic and political improvements and continued dollarization, and drawing policy implications from it. We advise against pursuing enforced dedollarization, and advocate a policy option that focuses instead on accelerating accommodative reforms, especially in the financial sector and on legal and institutional reforms. We also identify a host of institutional barriers that need to be overcome to prepare the groundwork for a natural process of de-dollarization.Cambodia; dollarization; exchange rates; currency board; hysteresis

Official Dollarization: Current Experiences and Issues, Cato Journal, Vol. 20, No. 2 (Fall 2000), 179-213.

The paper reviews the salient features of officially dollarized economies (with particular reference to Panama) and discusses costs and benefits of official dollarization. Also, the paper reviews existing and some potential seigniorage sharing arrangements and discusses conditions that are conducive to official dollarization, especially in Latin America.dollarization monetary unions seigniorage Panama Latin America

Evaluating the Impact of Macroeconomic Factors on the Level of Dollarization in Ukraine

The objectives of the article are identifying causal relationships between the macroeconomic determinants and the level of dollarization in Ukraine, as well as determining the activities for de-dollarization. The prerequisites, causes and consequences of dollarization have been covered. On the external grounds, dollarization is recognized as a manifestation of financial integration, on internal grounds, as a consequence of financial instability. The main types and forms of dollarization have been allocated. Forms of financial dollarization have been considered as: deposit, credit and monetary. The determinants that potentially impact the dollarization level have been allocated. According to the results of a correlation analysis, the thesis of direct strong connection between dollarization and currency deposits, i.e. the dominance of deposit dollarization, has been confirmed. In order to determine the causal nature of the interdependencies between variables and the level of dollarization, a Granger causality test was carried out, which confirmed the hypothesis of the significant influence of psychological attitudes and the distrust of economic agents towards the policies of government and monetary authorities. A set of macroeconomic, market and incentive de-dollarization activities have been proposed

Financial globalization: Unequal blessings

This paper presents a framework to analyze financial globalization. It argues that financial globalization needs to take into account the relation between money (particularly in its role as store of value), asset and factor price flexibility, and contractual and regulatory institutions. Countries that have the “blessed trinity” (international currency, flexible exchange rate regime, and sound contractual and regulatory environment) can integrate successfully into the (imperfect) world financial markets. But developing countries normally display the “unblessed trinity” (weak currency, fear of floating, and weak institutional framework). The paper defines and discusses two alternative avenues (a “dollar trinity” and a “peso trinity”) for developing countries to safely embrace international financial integration while the blessed trinity remains beyond reach.