Does dollarization benefit developing economies?
Issues and Background
Some countries have recently considered making another country's currency their own: in particular, adopting the dollar. This is
a highly consequential step for any country, one that has to be considered very carefully and, in our view, should not be done
without consultation with United States authorities. On one hand, dollarization offers the attractive promise of enhancing stability.
On the other hand, the country also must be prepared to accept the potentially significant consequences of doing without the
capacity independently to adjust the exchange rate or the direction of domestic interest rates. The implications for the United
States are also consequential. We do not have an a priori view as to our reaction to the concept of dollarization. We would also
observe that there are a variety of possible ways for a country to dollarize. But it would not, in our judgment, be appropriate for
United States authorities to extend the net of bank supervision, to provide access to the Federal Reserve discount window, or
to adjust bank supervisory responsibilities or the procedures or orientation of U.S. monetary policy in light of another country's
decision to dollarize its monetary system.
Secretary Robert E. Rubin, April 21, 1999
Our position on dollarization should start from the core assertion: A stable monetary order is the appropriate corollary to a free
trade agreement. Whether we are thinking in terms of our NAFTA partners or looking beyond to the Free Trade Area of the
Americas (FTAA), one of our primary objectives should be to establish a monetary union or common currency that would provide
a consistent unit of account across borders. When price signals are distorted through currency fluctuations, markets cannot
function at optimal levels. Individuals who bring their goods and services to the international marketplace are unfairly punished and
rightfully discouraged when currency movements turn legitimate profits into foreign exchange losses. If we believe in free trade
and free markets, we must work toward a common currency with the same fervor we bring to the effort to reduce trade barriers
and fight protectionism.
Shelton, April 22, 1999
Developing economies often experience high and unstable inflation rates when their governments
increase the money supply to finance higher levels of government spending. High and unstable
inflation rates result in a more unstable investment climate and a lower rate of economic growth.
When people lose faith in the domestic currency, it is not uncommon for another currency to be used
as a medium of exchange in the domestic economy. Because of its relative stability and use as
an international reserve currency, the U.S. dollar frequently is used for this purpose.
"Dollarization" is said to occur when the U.S. dollar replaces the domestic currency as the
official medium of exchange.
Advocates of dollarization suggest that developing economies that replace their less stable
domestic currency with the U.S. dollar experience a lower and more stable inflation rate. A lower
and more stable inflation rate, in turn, is expected to lead to a higher level of investment and
a faster rate of economic growth. This benefit is larger when the domestic monetary authorities
have established a poor track record in maintaining a stable domestic money supply.
Opponents of dollarization note that the domestic monetary authorities have no control over
the domestic money supply under this policy. The government of a dollarized economy will not be able to use
discretionary monetary policy to deal with domestic macroeconomic problems. If the domestic
economy experiences a business cycle that closely corresponds to the U.S.
economy's business cycle, this may present less of a problem (since the U.S. Fed might
engage in appropriate monetary policy responses). Even if the U.S. Fed can be trusted to
engage in "appropriate" policy responses, many countries are still reluctant to cede their
control over domestic macroeconomic policy to a foreign agency. Countries that replace their
national currencies with the dollar will also lose "seignorage," the profit made by governments
that issue token money (seignorage exists because the purchasing power of coin and paper money
exceeds the cost of producing the money).
Many U.S. policymakers argue that dollarization is an indication of the relatively high rate of
success that the Fed has experienced in maintaining a stable currency in recent years. There is
some concern, though, that foreign governments will attempt to exert political pressure to
encourage the Fed to pursue monetary policies that are not consistent with U.S. monetary policy
The introduction, and apparent success of the Euro in establishing a
common currency throughout much of Europe has encouraged discussions involving
the use of the dollar for a similar role in North and South America. Argentina had maintained a
fixed exchange rate (and full convertibility) with the dollar for over a decade and had
considered completely switching to the use of the dollar as a medium of exchange. An
economic and political crisis in Argentina (resulting in five Presidents in a two-week period),
however, resulted in the floating of the peso on February 11, 2002. Advocates of dollarization
have also made some inroads in Mexico. Panama has used the U.S. dollar
as its official currency since its creation as a nation. Ecuador adopted the dollar as
its currency in 2000. Despite U.S.
trade restrictions, the informal economy in Cuba relies on the U.S. dollar. The success of the Euro has
resulted in some discussion of dollarization in Canada. During the next few years, the dollarization
debate is likely to be a major policy issue in the U.S. and in countries experiencing currency
Primary Resources and Data
- Federal Reserve Board of Governors
The Federal Reserve Board of Governors web site contains information on the conduct of U.S.
monetary policy. As the debate over dollarization continues, this site is likely to contain
speech transcripts and other information relevant to the debate.
- Mark Bernkopf's Central Banking Resource Center
This web site contain links to the websites of virtually all central banks that maintain
an internet presence. These web sites often contain information about the conduct of monetary policy
in these countries.
- Free Trade Area of the Americas
This site is the home page of the Free Trade Area of the Americas, a proposed free trade area
that would encompass most of the countries of North and South America. Information about the nature
and status of this proposal is available at this site. It is likely that future discussions of a
common currency for North and South America would take place within this organization.
- U.S. Foreign Trade Statistics
This Census Bureau web site contains recent and historical data on U.S. imports, exports, trade balances,
and other relevant measures of trade. U.S. trade statistics with major trading partners are
provided for broad product categories.
- CNN's Financial Network's Currencies web site
CNN's list of current exchange rates provides information on the exchange rate between the dollar and
the currencies of our major trading partners.
- X-rates.com Currency Calculator
X-rates.com Currency Calculator provides online conversion between monetary balances for over 40 other currencies.
It also provides a graph of the last few month's exchange rate between any two of these currencies. This helps illustrate
the degree of exchange rate stability among these currencies.
- Joint Economic Committee, "Basics of Dollarization"
This July 1999 report (revised January 2000) contains a very useful
discussion of the practical issues associated with dollarization. It describes the history of
dollarization, alternative methods of dollarization, and introduces arguments for and against
- Alan M. Taylor, "Dollarization as a Technology Import"
Alan M. Taylor discusses the issues surrounding dollarization in this May 19, 2000 San Francisco Federal Reserve Board
Economic Letter. This article contains a very nice history of past monetary crises in Argentina and the movement towards
dollarization. Taylor also provides an interesting discussion of the network externalities associated with the use of a
- Mark Falcoff, "Dollarization for Argentina? For Latin America"
In this April 1999 Latin
American Outlook article, Mark Falcoff provides a solid discussion
of the pros and cons associated with dollarization. He notes that the
potential benefits include price stability, less exchange-rate risk,
lower trading costs, lower interest rates, and higher rates of economic
growth. The potential cost includes a loss of monetary policy autonomy.
Different Perspectives in the Debate
- Dallas Federal Reserve District Bank, "Dollarization: A Common Currency for the Americas?"
This website contains links to the text of a variety of papers and speeches
delivered during a March 6-7, 2000 conference organized by the Dallas
Fed. These documents provide a nice overview of the major issues surrounding
dollarization. (The Adobe acrobat viewer plugin is required to view
this document. You may download this viewer by clicking here.)
- Steve H. Hanke and Kurt Schuler, "A Dollarization Blueprint
In this Cato Institute Foreign Policy Briefing, Steve H. Hanke
and Kurt Schuler argue that Argentina would benefit from dollarization.
They note that Argentina has increased currency stability in recent
years by maintaining a fixed exchange rate with the dollar. Replacing
the peso with the dollar would remove any remaining exchange-rate risk
and would be expected to result in lower interest rates and a faster
rate of economic growth. Hanke and Schuler suggest that the benefits
from having a stable currency outweigh the costs of foregone seignorage
and of giving up domestic control over monetary policy.
- C. Fred Bergsten, "Dollarization in Emerging-Market Economies and its Policy
Implications for the United States"
C. Fred Bergsten, in this April 22, 1999 testimony, examines the conditions under which
dollarization is beneficial to an economy. He concludes that a dollarization policy
is desirable only in countries that:
- are relatively small and have a high volume of international trade (thereby being
subject to relatively large exchange-rate shocks),
- have experienced recent hyperinflation or a history of hyperinflation, or
- countries that have a high volume of trade with the U.S.
- Francois R. Velde and Marcelo Veracierto, "Dollarization in Argentina"
In this June 1999 Chicago Fed Letter, Francois R. Velde and Marcelo
Veracierto examine the costs and benefits of dollarization in Argentina.
They argue that dollarization will be more successful if it is done
in collaboration with the U.S. rather than unilaterally. (The Adobe
acrobat viewer plugin is required to view this document. You may download
this viewer by clicking here.)
- Paul Krugman, "Monomoney Mania"
In this April 15, 1999 Slate article, Paul Krugman argues that the use of fewer currencies is
not necessarily desirable. He notes that different countries may be at different stages of their
business cycles. When one economy is growing faster than another, wages and prices in the faster
growing economy will rise relative to those in the slower growing economy. Under a system of
flexible exchange rates, an adjustment in the exchange rate will accommodate this adjustment without
requiring either inflation or deflation in either country. If both countries shared a common
currency, however, such an adjustment would require changes in the levels of wages and prices in
one or both countries. Krugman argues that it is simpler to allow the exchange rate to shift in
such a situation than to require the adjustment of thousands of wages and prices.
- Paul Krugman, "Argentina's Money Monomania"
In this online followup to the article listed above, Paul Krugman argues that Argentina should
devalue its currency. He suggests that the cost of maintaining a fixed exchange rate with the
dollar is doing more harm than good for Argentina's economy.
- Paul Krugman, "Don't Laugh at Me, Argentina"
Paul Krugman discusses the cost of dollarization in Argentina in this July 7, 1999 article in
Slate. He notes that Argentina was able to gain credibility by maintaining convertibility
between dollars and pesos. The cost of this, though, is an inability to conduct desirable monetary
- U.S. Treasury Secretary Robert E. Rubin, "Remarks on Reform
of the International Financial Architecture"
U.S. Treasury Secretary Robert E. Rubin provides warnings of the potential
costs associated with dollarization in this April 21, 1999 speech. He
notes that countries that engage in dollarization will lose control
over their domestic monetary policy. Rubin also suggests that the Fed
will not provide bank supervision or discount window services to countries
that adopt this policy.
- Senate Banking Committee, "Citizen's Guide to Dollarization"
This Senate Banking Committee document weighs the pros and cons of dollarization. It is
argued that dollarization can provide benefits for both the U.S. and any country that
pursues this policy.
- Thomas J. Courchene, "Towards a North-American Common Currency:
An Optimal Currency Area Analysis"
Thomas Courchene argues that Canada's independent monetary policy and
exchange rate flexibility between the U.S. and Canadian dollars have
resulted in unnecessary instability in the Canadian economy. He argues
that, given the high volume of trade between the U.S. and Canada, either
a fixed exchange rate or a common currency should be adopted.
- Canadian Broadcasting Corporation, "The Dollarization Debate"
This website provides a transcript of (and a RealPlayer video of) a discussion of the arguments for dollarization
in both Argentina and Canada. It is argued that dollarization would force Canadian firms to be more competitive since they could not
rely on currency depreciation to keep their exports affordable.
- Kurt Schuler, "A Contingency Plan for Dollarizing Hong Kong"
Kurt Schuler, in this online HKCER
Letters article, argues that Hong Kong would benefit from dollarization.
He notes that the Hong Kong dollar suffered several speculative attacks
as a result of the Asian financial crisis. Schuler suggests that a full
conversion to the U.S. dollar would improve credibility and reduce speculation.
- Tsang Shu-ki, "A Critical Comment on Government-sponsored Dollarization
as a Rescue
Tsang Shu-ki discusses some of the problems associated with dollarization
in the Hong Kong economy. He argues that the choice of a particular
fixed exchange rate is somewhat arbitrary and that economies should
preserve the option of exiting from a fixed-exchange rate system if
that is in the national interest. The cost of exit under dollarization,
however, is substantially higher than under alternative fixed-exchange
- Lawrence H. Summers, Testimony before the Senate Banking, Housing
and Urban Affairs Committee, April 22, 1999
Lawrence H. Summers, the Deputy Secretary of the U.S. Treasury, discusses
the implications of dollarization in his testimony before the Senate
Banking, Housing, and Urban Affairs Committee. He indicates that fixed
exchange rate regimes (and dollarization) offers stability to importers
and exporters, but requires that the country gives up control of its
domestic money supply. Summers notes that Panama, a dollarized economy,
is the only Latin American economy that has an active 30-year fixed
rate mortgage market. This, he argues, is a result of the credibility
provided by dollarization.
Summers notes that the U.S. economy benefits from dollarization since
these economies are providing the U.S. with an interest-free loan when
they acquire dollars for their own monetary use. A second benefit to
the U.S. occurs as a result of the increase in trade that would be expected
to result from a larger currency area. An additional potential benefit
from dollarization is additional economic and political stability in
the region. Summers states that the U.S. Fed will not provide deposit
insurance or bank supervision services to dollarized economies.
- Wayne Angell, Testimony before the Senate Banking, Housing and
Urban Affairs Committee, April 22, 1999
Wayne Angell argues in support of dollarization in his testimony before
the Senate Banking, Housing and Urban Affairs Committee. He argues that
dollarization would enhance economic stability and economic growth in
both Mexico and Argentina. Angell argues that the Fed should assist
the central banks in these countries in establishing a more rigid system
of bank regulation and supervision. He also suggests that dollarized
economies be invited to join NAFTA.
- Judy Shelton, Testimony before the Senate Banking, Housing and
Urban Affairs Committee, April 22, 1999
Judy Shelton lends her support to the dollarization process in her testimony
before the Senate Banking, Housing and Urban Affairs Committee. She
notes that high interest rates in Mexico have discouraged investment
and slowed economic growth. Dollarization would be expected to reverse
this problem. Shelton notes that U.S. monetary policy is already taking
global economic conditions into account and suggests that dollarization
would not necessarily change the monetary policy pursued by the Fed.
- Robert J. Barro, "From Seattle to Santiago, Let the Dollar Reign"
Robert Barro argues for dollarization in Argentina in this Hoover Digest reprint of a March 8,
1999 New York Times article. He suggests that the U.S. should actively support dollarization
by compensating Argentina for the lost seignorage. Barro suggests that dollarization could help
reform monetary institutions in countries that have experienced problems in maintaining
- Guillermo A. Calvo, Testimony before the Senate Banking, Housing
and Urban Affairs Committee, April 22, 1999
In his testimony before the Senate Banking, Housing and Urban Affairs
Committee, Guillermo A. Calvo argues that dollarization is especially
valuable for emerging-market economies that possess large dollar-denominated
debts. These countries are very likely to experience high rates of inflation
and have a larger debt burden as a result of currency devaluation. He
argues that financial market "contagion" will be less likely if such
economies are dollarized, since dollarized economies are not subject
to currency-devaluation risk.
- Guillermo A. Calvo, "On Dollarization"
In this April 20, 1999 paper, Guillermo A. Calvo examines the rationale for
dollarization in an emerging market economy. He notes that in most emerging
market economies, a large share of assets and liabilities are already
denominated in foreign exchange. Calvo argues that Latin American economies
are already substantially affected by monetary policy and economic conditions
in the U.S. He suggests that some emerging market economies would benefit from
dollarization since it provides for a more predictable and credible monetary
policy. (To view this document, the Adobe acrobat viewer plugin is required.
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- Catherine L. Mann, Testimony before the Senate Banking, Housing
and Urban Affairs Committee, April 22, 1999
Catherine Mann describes the costs and benefits associated with dollarization
during her testimony before the Senate Banking, Housing and Urban Affairs
Committee. She notes that partial dollarization has occurred in a large
share of countries experiencing economic difficulties. This has occurred
as a result of private-sector initiatives rather than a policy-initiated
process. Mann notes that dollarization will not correct structural problems
in these economies, nor will it improve the quality of fiscal policy
decisions. She argues that dollarization (or a fixed-exchange rate system)
will not work well in the long run since it does not allow relative
prices to differ across countries in response to different rates of
productivity growth. Mann suggests that the most appropriate strategy
is to correct the structural problems that these countries are experiencing.
- John Chown, "Currency Boards or Dollarization - Solutions or Traps?"
In this August 7, 1999 Royal Institute of International Affairs Briefing Paper,
John Chown examines alternative methods of providing a stable money supply in Russia.
The options considered include dollarization and a currency board arrangement under
which the U.S. dollar (or other stable currency) serves as a reserve asset and is
freely convertible at a fixed rate. Chown notes that a practical difficulty with
either a currency board or dollarization is the cost of acquiring foreign currency
reserves. He notes the problems that Russia would face if there were external control
of its monetary policy. Chown argues that either dollarization or a currency board
system would make it more difficult for the U.S. to maintain control of its domestic
money supply (since it becomes more difficult to monitor the domestic money supply
when a larger share of the domestic currency circulates abroad. He suggests that the
best strategy for Russia would be the use of a currency board that receives its
credibility from a stable foreign currency while allowing the Russian government to
receive seignorage. (To view this document, the Adobe acrobat viewer plugin is required.
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- International Monetary Fund Economic Forum,
This is a transcript of am International Monetary Fund forum on dollarization in Latin
America. Participants in this forum are: Guillermo Otiz (Governor of the Central Bank of Mexico),
Miguel Kiguel (Chief of Argentina's Cabinet of Advisors and Undersecretary of Finance, Ministry of Economy, and
Public Works and Services), Jeffrey Frankel (Brookings Institute and former member of the
U.S. Council of Economic Advisers), and Eduardo Borensztein
(Division Chief of the IMF Developing Studies Division). This forum provides a good discussion of
the advantages and disadvantages of dollarization.