Persistence of dollarization after price stabilization |
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Authors: | Veronica Rappoport |
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Affiliation: | Columbia University, Columbia Business School, New York, NY 10027, USA |
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Abstract: | Credit contracts in developing countries are often denominated in foreign currencies, even after many of these economies succeeded in controlling inflation. This paper proposes a new interpretation of this apparent puzzle based on the demand for insurance against real shocks: the fact that devaluations occur more frequently in adverse states of the world provides a motive for holding dollar assets. This approach implies a complementarity between the optimal monetary policy and the currency denomination of contracts. When a large proportion of liabilities is denominated in a foreign currency, the optimal exchange rate volatility is low, which reinforces the demand for dollar assets. |
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Keywords: | Dollarization Nonexclusive contracts Multiple equilibria Underinsurance |
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