Dollarization and financial integration
Cristina Arellano and
Jonathan Heathcote ()
No 385, Staff Report from Federal Reserve Bank of Minneapolis
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.
Keywords: Financial crises; Foreign exchange administration (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (3) Track citations by RSS feed
Downloads: (external link)
Journal Article: Dollarization and financial integration (2010)
Working Paper: Dollarization and Financial Integration (2007)
Working Paper: Dollarization and financial integration (2007)
Working Paper: Dollarization and Financial Integration (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:385
Ordering information: This working paper can be ordered from
Access Statistics for this paper
More papers in Staff Report from Federal Reserve Bank of Minneapolis Contact information at EDIRC.
Series data maintained by Jannelle Ruswick ().