- Adam Bennett, Eduardo Borensztein, and Tomás Baliño
- Published Date:
- March 1999
Dollarization comprises various financial assets and motivations. In part, it is a result of increased integration of capital markets with the rest of the world, but it may also represent a flight from domestic money in times of high inflation. While dollarization is important in its own right, it is but one of the many consequences that result from these underlying factors. The benefits of dollarization—most generally the greater integration of the economy with international markets and the deepening of domestic intermediation—largely follow from an increased openness of capital markets. The risks, especially the exposure of the banking and financial systems to potential foreign exchange crises, are also linked to more open capital accounts. Thus, the considerations that apply to integration with international capital markets, such as the need for proper sequencing of reforms and, particularly, the importance of a sound financial market environment, apply a fortiori to dollarization. Dollarization can aggravate the usual problems in these circumstances, including the instability of money demand and of the exchange rate under flexible exchange rates.
Most of the considerations that apply to dollarization in the design of IMF programs really concern the underlying macroeconomic causes, and IMF programs have not for the most part contained specific measures to deal with dollarization in itself. But substantial dollarization does necessitate special attention to certain areas, in particular in dealing with less stable monetary aggregates in assessing the potential advantages—in certain circumstances—of exchange rate targeting in inflation stabilization, and in considering the need to monitor carefully the vulnerability of the banking and foreign exchange markets.