Systemic Risk, Dollarization, and Interest Rates in Emerging Markets: A Panel-Based Approach |
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Authors: | Bacha, Edmar L. Holland, Marcio Goncalves, Fernando M. |
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Affiliation: | Edmar Bacha is executive director of the Institute of Economic Policy Studies (Casa das Garças), Brazil; his email address is edmarbacha{at}iepecdg.com Márcio Holland (corresponding author) is professor of economics at São Paulo School of Economics, Fundação Getulio Vargas, Brazil, and Conselho Nacional de Desenvolvimento Científico e Tecnológico (CNPq) researcher Fernando M. Gonçalves is an economist at JGP Asset Management; his email address is fmg215{at}gmail.com |
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Abstract: | This study investigates the impact of systemic risks and financialdollarization on real interest rates in emerging economies.Higher systemic risks induce both higher real interest ratesand increased dollarization. Using appropriate instruments forthe dollarization ratio, the study overcomes the simultaneousequation problem and correctly estimates a negative coefficientfor the dollarization ratio in the interest rate equation. Itconfirms the theoretical prediction that a strategy of "dedollarizing"the economy will raise the equilibrium domestic real interestrate if the strategy fails to address fundamental macroeconomicrisks. Even so, it also finds that this effect is small, aftercontrolling for the risks of dilution and default. The resultsbring to light the systemic-risk reasons for high interest ratesin emerging economies—and contribute to evaluating thedifficulties of dedollarization policies. |
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