Currency Substitution in Latin America : Lessons from the 1990s
The authors study how agents in Latin America allocate their balances between dollar-denominated and domestic currency-denominated accounts. They empirically determine the causes of currency substitution, its significance in recent banking crises,...
| Main Authors: | , , |
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| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2000/05/437673/currency-substitution-latin-america-lessons-1990s http://hdl.handle.net/10986/18845 |
| Summary: | The authors study how agents in Latin
America allocate their balances between dollar-denominated
and domestic currency-denominated accounts. They empirically
determine the causes of currency substitution, its
significance in recent banking crises, and the link between
currency substitution, and volatility in macroeconomic
aggregates. Their findings: The ratio of dollar deposits to
broad money is strongly influenced by expectations of
depreciation. They show that depositors in Latin America
face some uncertainty and frictions when making their
portfolio decisions. They explore the macroeconomic
consequences of a dollarized economy. In particular, they
find that, in the presence of currency substitution, past
banking crises are good predictors of future crises. In
other words, having a highly dollarized economy, increases
the response of the banking system when there is a bad
shock, which halts the outflow of capital. Once an economy
is in crisis, however, having more dollar-denominated
deposits in the banking system, increases the probability of
a longer crisis in the future, because it increases exchange
rate exposure in an already weak banking system. Finally,
they show that the volatility of macroeconomic variables
linked to the financial system, increases whenever the
economy becomes more dollarized, which in turn makes the
choice of monetary targets more difficult. |
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