Dollarization Dynamics

Tomás E. Caravello, Pedro Martinez-Bruera and Iván Werning

No 31296, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This study explores the consequences of dollarizing an economy with an initial dollar shortage. We show that the resulting transitional dynamics are tantamount to that of a “sudden stop”: consumption of tradable goods fall, the real exchange rate depreciates abruptly by a discrete drop in domestic prices and wages followed by a gradual appreciation from positive inflation. With nominal rigidities the economy first falls into a recession. This is true even if all prices and wages are allowed to adjust flexibly on impact. The subsequent recovery in activity always “overshoots” the steady state: the non-tradable sector transitions from the initial recession to a boom, then asymptotes to its steady state.

JEL-codes: E10 F30 (search for similar items in EconPapers)
Date: 2023-06
New Economics Papers: this item is included in nep-mon and nep-opm
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