Dollarization Explained

This reading, Dollarization Explained, explains why countries sometimes find it advantageous to forego their own currencies and independent monetary policy and opt instead to use the currency of another country. Focusing mostly on Lain American countries, Slivinski considers full dollarization and also the less extreme “soft” forms it can take, such as currency boards and exchange rate targeting. He points out that dollarization can have negative as well as positive effects on the countries that adopt it.

1. Define the following terms used in the reading:

   a. store of value
   b. unit of account
   c. medium of exchange
   d. legal tender
   e. risk premiums
   f. real interest rate
   g. central bank
   h. lender of last resort
   i. credible commitment
   

2. What is dollarization?

   a. What is the distinction between “official” and “unofficial” dollarization?
   b. Which form of dollarization is more common?
   c. Why does unofficial dollarization occur?
   d. Which countries have the highest degree of unofficial dollarization?
   

3. What does Slivinski mean by “soft” dollarization? How does it differ from official dollarization?

4. What benefits do countries expect to garner if they dollarize? Is dollarization guaranteed to provide these benefits? Explain.

5. What costs are imposed on countries that dollarize?

6. What does Slivinski see as the perils of soft dollarization?

   a. How do the experiences of Ecuador and Argentina exemplify these perils?
   b. When it comes to controlling inflation, how do central banks in developing countries measure up?
   c. How would Slivinski explain this?
   

Source: “Dollarization Explained.” Stephen Slivinski, Region Focus, Federal Reserve Bank of Richmond, Fall 2008, 2-5.

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