Dollarization as a Signaling Device
The objective of this paper is to point out that dollarization may be used as a signaling device. To this end, we introduce into a standard monetary policy model two types of governments: good and bad. Information is asymmetric, the government type is uncertain and the policy of the bad government is suboptimal. This uncertainty does not allow the good government to achieve the first best outcome even though it conducts optimal policy. Since, the bad government would never dollarize, the good government by dollarizing reduces uncertainty about the type of government and achieves the first best allocation. Here, unlike in models emphasizing the time inconsistency motive for dollarization, it does not change the actual policy. Thus, dollarization plays the role of a signaling device rather than a commitment device. (original abstract)
- Albanesi S., Chari V.V., Christiano L.J. (2003), Expectation traps and monetary policy, Review of Economic Studies, 70(4), 715-741.
- Alesina A., Barro R.J. (2002), Currency unions, The Quarterly Journal of Economics, 117(2), 409-436.
- Arellano C., Heathcote J. (2010), Dollarization and financial integration, Journal of Economic Theory, 145(3), 944-973.
- Calvo G.A. (2001), Capital markets and the exchange rate with special reference to the dollarization debate in Latin America, Journal of Money, Credit and Banking, 33(2), 312-334.
- Chari V.V., Kehoe P.J. (1999), Optimal fiscal and monetary policy, in: J. Taylor, M. Woodford (eds), Handbook of Macroeconomics, 1, North-Holland, Amsterdam.
- Click R.W. (1998), Seigniorage in a cross-section of countries, Journal of Money, Credit and Banking, 30(2), 154-171.
- Cooley T.F., Quadrini V. (2001), The cost of losing monetary independence: the case of Mexico, Journal of Money, Credit and Banking, 33(2), 370-397.
- Cooper R.W., Kempf H. (2001), Dollarization and the conquest of hyperinflation in divided societies, Federal Reserve Bank of Minneapolis Quarterly Review, 25(3), 3-12.
- Lucas R.J., Stokey N.L. (1983), Optimal fiscal and monetary policy in an economy without capital, Journal of Monetary Economics, 12(1), 55-93.
- Mendoza E.G. (2001), The benefits of dollarization when stabilization policy lacks credibility and financial markets are imperfect, Journal of Money, Credit and Banking, 33(2), 440-474.
- Phelan C. (2006), Public trust and government betrayal, Journal of Economic Theory, 130(1), 27-43.
- Svensson L.E.O. (1985), Money and asset prices in a cash-in-advance economy, Journal of Political Economy, 93(5), 919-944.