Dollarization, bailouts, and the stability of the banking system

Douglas Gale () and Xavier Vives

No 185, HWWA Discussion Papers from Hamburg Institute of International Economics (HWWA)

Abstract: Central bank policy suffers from time-inconsistency when facing a banking crisis : A bailout is optimal ex post but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is good when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. However, a very severe moral hazard problem could make dollarization Undesirable. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR.

Date: 2002
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Related works:
Journal Article: Dollarization, Bailouts, and the Stability of the Banking System (2002)
Working Paper: Dollarization, Bailouts, and the Stability of the Banking System (2002)
Working Paper: Dollarization, Bailouts and the Stability of the Banking System (2001)
Working Paper: Dollarization, bailouts, and the stability of the banking system (2001)
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