earlier resource reallocation led to large current account deficits, but could also be a threat to surplus countries with large external liabilities and overstretched domestic credit markets.

# **Myth 14.  Dollarized economies are not subject to Dutch disease.**

Dutch disease could strike even in countries that do not have a national currency (full dollarization).<sup>35</sup> Just as in other countries, an export boom or a sharp increase in capital inflows may induce changes in the relative price and resource reallocation, squeezing profitability and output of the non-booming tradable sector.

Whether partially (or unofficially) dollarized economies experience Dutch disease is an open question. There is no study that systematically investigates the presence of Dutch disease in these economies.<sup>36</sup> Under partial dollarization, individuals use US dollars or other hard currency to make transactions (payment dollarization) and protect their purchasing power of financial assets (financial dollarization).<sup>37</sup> In these economies, typically the bulk of large-scale transactions, both tradable and non-tradable, takes place in US dollars or other hard currency, and the national currency is used only for small, local transactions. If local prices and wages are also set in US dollars, then the movement in the real exchange rate does not affect overall production cost, and real appreciation does not erode export competitiveness of the tradable sector.

# **Myth 15.  Dutch disease should be avoided through policy intervention.**

Dutch disease adjustments driven by an export boom are an appropriate response to a country’s increased wealth and do not automatically justify government intervention. Real appreciation associated with an export boom is not a cause of great concern as long as it reflects the country’s strengthened fundamentals. Under such circumstances, countries should not be too worried about export specialization. This is by no means to discourage, or deny the benefits of, export diversification. Diversification is a slow process, and resource rents can be used effectively as levers for broader development, including diversification of the production or export base (see Section 4).

Corden (2012) argues that the best policy response to Dutch disease would be to “do nothing”, and allow the currency to appreciate and lift the real consumption wage (as a result of lower import prices). An intervention to prevent or reverse real appreciation is a welfare-reducing policy and can impose costs in the form of forgone opportunities to increase real expenditure, including possible underinvestment at home. Piecemeal protectionism to safeguard industries affected by Dutch disease would increase the adverse effect on other industries that are also affected by the stronger currency, and would do more damage to the economy than do nothing. A similar view is also expressed by Rogoff (2005), who warns against government intervention to stop Dutch disease, which is far more likely to create serious

> 35 Resource rich countries that have adopted full dollarization include Ecuador and Timor-Leste.  Another fullydollarized economy, El Salvador, receives a large inflow of remittances.

> 36 Existing Dutch disease studies for partially dollarized countries disregard completely the relevance of the real exchange rate, and make hasty policy recommendations to “cure” Dutch disease, thereby preserving export competitiveness.

> 37 Among highly dollarized economies, Cambodia, Mongolia, Lao and Vietnam are resource exporters and net recipients of large foreign currency inflows (aid, FDI and other flows).

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