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      Currency interdependence and dollarization

      Dutu, Richard
      DOI
       10.1016/j.jmacro.2008.03.002
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      Dutu, R. (2008). Currency interdependence and dollarization. Journal of Macroeconomics, 30(4), 1673- 1687.
      Permanent Research Commons link: https://hdl.handle.net/10289/2716
      Abstract
      This paper constructs a search model of currency interdependence, and uses it to examine how in dollarized economies the foreign currency reacts to various shocks to the domestic currency. Currency interdependence is generated by allowing sellers to take into account their outside option of trading with the domestic currency while bargaining with buyers holding the foreign currency. The shocks consist in movements in the domestic interest rate, domestic inflation and the domestic currency’s market power. We show that if the purchasing power of the domestic currency is low, any shock that increases its value, such as a higher domestic interest rate, translates into a depreciation of the foreign currency. However, the result is opposite when the purchasing power of the domestic currency is high. We show that when money is indivisible these shocks can drive in or out the foreign currency. When money is divisible, this currency substitution effect is more limited. We use our results to discuss the opportunity of various de-dollarization policies and show that some can be counterproductive.
      Date
      2008
      Type
      Journal Article
      Publisher
      Elsevier
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      • Management Papers [1098]
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