Description

The economic literature has examined deposit dollarization in nominal terms, typically focusing on the ratioof foreign currency deposits to broad money. However, while private agent demand for foreign currencymay remain unchanged in foreign currency terms, there could be large fluctuations in the dollarization ratiosimply due to exchange rate movements. This paper proposes a new approach to measuring dollarizationthat removes these exchange rate effects, and demonstrates that beyond the variance of inflation anddepreciation, the level of inflation and size of depreciation also matter for dollarization. While dollarizationin nominal terms surged during the recent global financial crisis, there was a downward trend in real terms.Employing a set of econometric estimators, this paper investigates whether “real” dollarization during2006–09 was associated with the crisis, and the role of initial macroeconomic conditions, quality ofinstitutions, risk aversion, and prudential measures. We find that exchange rate appreciation and reductionsin sovereign risk do moderate dollarization; but the results for global volatility have low statisticalsignificance, perhaps because global shocks tend to preserve, to a large extent, relative attractiveness offoreign assets. Nonetheless, estimated impulse-response functions point to a large but short-lived positiveimpact of global volatility on dollarization, which could reflect economic agents heightened concerns aboutspillover effects of global uncertainty on the domestic economy.

More publications in this series: Working Papers

More publications by: Nkunde Mwase ; Francis Y. Kumah