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Mr. Alex Mourmouras and Mr. Steven Russell
Large stocks of U.S. dollars and other hard currencies circulate in the transition economies, in Latin America, and in other countries that have experienced macroeconomic mismanagement. Using a monetary model that combines the legal restrictions and crime-theoretic traditions, this paper demonstrates how leaky exchange controls lead to currency substitution and progressive dollarization. The paper also analyzes the impact of dollarization on the ability of governments to earn seigniorage, the dynamics of dollarization in a growing economy, and the central role of expectations—specifically, confidence in the domestic currency—in determining the extent of dollarization and, potentially, in reversing it.
Ms. Anne Marie Gulde, Mr. David S. Hoelscher, Mr. Alain Ize, Mr. Dewitt D Marston, and Mr. Gianni De Nicolo

E mpirical evidence suggests that financial dollarization may increase the vulnerability of financial systems to solvency and liquidity risks. Simple cross-country estimates of the impact of dollarization on some key financial soundness indicators, while controlling for changes in underlying macro-volatility, are consistent with the hypothesis that increased dollarization may increase financial vulnerability. In particular, the variance of deposit growth is positively and significantly correlated with dollarization, suggesting that dollarized financial systems

Mr. Geoffrey J Bannister, Mr. Jarkko Turunen, and Malin Gardberg
Despite significant strides in financial development over the past decades, financial dollarization, as reflected in elevated shares of foreign currency deposits and credit in the banking system, remains common in developing economies. We study the impact of financial dollarization, differentiating across foreign currency deposits and credit on financial depth, access and efficiency for a large sample of emerging market and developing countries over the past two decades. Panel regressions estimated using system GMM show that deposit dollarization has a negative impact on financial deepening on average. This negative impact is dampened in cases with past periods of high inflation. There is also some evidence that dollarization hampers financial efficiency. The results suggest that policy efforts to reduce dollarization can spur faster and safer financial development.
Mr. Alex Mourmouras and Mr. Steven Russell

Large stocks of U.S. dollars and other hard currencies circulate in the transition economies, in Latin America, and in other countries that have experienced macroeconomic mismanagement. Using a monetary model that combines the legal restrictions and crime-theoretic traditions, this paper demonstrates how leaky exchange controls lead to currency substitution and progressive dollarization. The paper also analyzes the impact of dollarization on the ability of governments to earn seigniorage, the dynamics of dollarization in a growing economy, and the central role of expectations—specifically, confidence in the domestic currency—in determining the extent of dollarization and, potentially, in reversing it.

Mr. Geoffrey J Bannister, Mr. Jarkko Turunen, and Malin Gardberg

Front Matter Page Asia and Pacific Department Contents Abstract I. INTRODUCTION II. LITERATURE AND THEORY III. MEASURING DOLLARIZATION AND FINANCIAL DEVELOPMENT IV. METHOD Policy variables in P Structural variables in S Dollarization variables in D Estimation strategy V. RESULTS Financial Depth Financial Access and Efficiency Robustness VI. CONCLUSION VII. REFERENCES TABLES 1. The Impact of Dollarization on Financial Debt 2. Dollarization and Financial Development in Countries with a History of High