Dollarization and financial integration
By: Cristina Arellano and Jonathan Heathcote.
Contributors: Heathcote, Jonathan.; Board of Governors of the Federal Reserve System (U.S.)
Series: International finance discussion papers -- no. 890; International finance discussion papers (Online) -- no. 890.
Publisher: Federal Reserve Board
Published: 2007
Place of publication: Washington, D.C
Language: eng
Format: Electronic resource
Description: "How does a country's choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing.  We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets.  We compare a floating regime to full dollarization.  We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets.  Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration.  This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union.  In each case, spreads on foreign currency government debt declined substantially around the time of regime change"--Federal Reserve Board web site.
Notes: Title from PDF file as viewed on 4/23/2007.

Includes bibliographical references.

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Mode of access: World Wide Web.