Dollar Shortages and Crises

Abstract

Emerging markets do not handle adverse shocks well. In this paper, I will outline an explanation of why emerging markets are so fragile, and why they may adopt contractual mechanisms -- such as a dollarized banking system -- that increase their fragility. I draw on this analysis to explain why dollarized economies may be prone to dollar shortages and twin crises. The model of crises described here differs in some important aspects from what is now termed the first, second, and third generation models of crises. I then examine how domestic policies, especially monetary policy, can mitigate the adverse effects of these crises. Finally, I will ask if there is a constructive role for international financial institutions both in helping to prevent the crises and in helping resolve them.