Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy

Enrique Mendoza and Eugenio Rojas

IMF Economic Review, 2019, vol. 67, issue 1, No 7, 174-214

Abstract: Abstract “Liability dollarization,” namely intermediation of capital inflows in units of tradables into domestic loans in units of aggregate consumption, adds three important effects driven by real exchange rate fluctuations that alter standard models of Sudden Stops significantly: changes on the debt repayment burden, on the price of new debt, and on a risk-taking incentive (i.e., a negative premium on domestic debt). Under perfect foresight, the first effect makes Sudden Stops milder and multiple equilibria harder to obtain. The three effects add an “intermediation externality” to the macroprudential externality of standard models, which is present even without credit constraints. Optimal policy under commitment can be decentralized equally by taxing domestic credit or capital inflows, and hence capital controls as a separate instrument are not justified. This optimal policy is time inconsistent and follows a complex, nonlinear schedule. Quantitatively, an optimized pair of constant taxes on domestic debt and capital inflows makes crises slightly less likely and yields a small welfare gain, but other pairs reduce welfare sharply. For high effective debt taxes, capital controls and domestic debt taxes are again equivalent, and for low ones, welfare is higher with higher taxes on domestic debt than on capital inflows.

JEL-codes: E31 E37 E52 F41 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Downloads: (external link)
http://link.springer.com/10.1057/s41308-018-0070-8 Abstract (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy (2018)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pal:imfecr:v:67:y:2019:i:1:d:10.1057_s41308-018-0070-8

Ordering information: This journal article can be ordered from
http://www.springer. ... cs/journal/41308/PS2

DOI: 10.1057/s41308-018-0070-8

Access Statistics for this article

More articles in IMF Economic Review from Palgrave Macmillan, International Monetary Fund
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().