Castillo-Bardalez, Paul
(2007)
Macroeconomic models for studying monetary policy in economies with partial dollarisation.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis studies how monetary policy should be conducted in emerging economies where the domestic currency has been partially replaced by a foreign currency, a phenomenon called 'dollarisation'. The central question is how different forms of dollarisation affect both the transmission mechanism and the goals of the central bank. A general overview and the motivation of these topics are discussed in the first and second chapters. The third chapter, 'Optimal Monetary Policy and Endogenous Price Dollarisation', shows that having two units of account may be optimal for economies with large sector specific productivity shocks when prices are sticky. In this case, optimal monetary policy implies a certain degree of exchange rate smoothing. In the fourth chapter, 'Monetary Policy and Currency Substitution' we use a fully micro-founded general equilibrium model where currency substitution is endogenously determined to show how currency substitution can make inflation stabilisation more costly, thus inducing a higher degree of aggregate volatility. We also show that currency substitution does not affect the central banks capability to determine inflation and that in this case exchange rate smoothing is not optimal. The effect of income distribution on price dollarisation is studied in the fifth chapter. This chapter shows that income inequality can generate an upper boundary for price dollarization In the final chapter, 'Dollarisation Persistence and Individual Heterogeneity', we study how the limited capability to process financial information of participants in the dollar deposit market can induce very persistent degrees of financial dollarisation. We further provide empirical evidence supporting our claim.
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