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Financial D o llarization Eduardo Levy Yeyati Universidad Torcuato Di Tella Presentation at the Office of the Chief Economist Inter-American Development Bank November 2, 2004 Outline Financial dollarization Definition and measurement Drivers Concerns Prognosis Definition

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financial d o llarization eduardo levy yeyati universidad torcuato di tella

Financial DollarizationEduardo Levy YeyatiUniversidad Torcuato Di Tella

Presentation at the Office of the Chief Economist

Inter-American Development Bank

November 2, 2004

outline
Outline
  • Financial dollarization
    • Definition and measurement
    • Drivers
    • Concerns
    • Prognosis
definition
Definition
  • Currency substitution (CS): foreign currency (dollar) as means of payment/unit of account
  • Asset substitution (AS): dollar as store of value
  • Financial dollarization: holding by residents of dollar assets and liabilities AS but not necessarily CS
    • Argentina 2002 & Uruguay 2002
drivers
Drivers
  • Hedging (Ize and LY, 1998, 2003)
    • Reverse causality: Fear of floating may perpetuate FD
  • Time inconsistency (Calvo and Guidotti, 1990)
    • CPI indexation?
  • Implicit guarantees (Burnside et al., 1999), peg trap (De la Torre et al., 2003),
  • Currency-blind regulation & safety nets (Broda and LY, 2001, 2003)
  • Institutions (Rajan, 2004)
  • Offshorization (LY, 2004)
concerns
Concerns
  • RER exposure
    • Amplifies cycles (debt deflation or balance sheet effects)
      • Procyclical capital flows due to correlation between leverage ratio and external shocks Pocyclical monetary policy
    • Increases financial fragilities
amplifies cycles
Amplifies cycles

Source: Levy Yeyati (2004)

increases f inancial fragility
Increases financial fragility
  • FD associated with greater banking fragility (z-scores and NPL ratios) and deposit volatility (de Nicoló et al., 2003)
  • FD increases the propensity to suffer sudden stops (Calvo, et al., 2003)
dollarization financial depth
Dollarization & Financial Depth

Hong Kong

Lebanon

Vanuatu

Notes:. The cofficient on dollar_avg is -0.005 with a t-statistic of -5.27.

fd where do we stand
FD: Where do we stand?
  • The preliminary evidence confirms some of the concerns and cast doubt on the financial depth argument
    • Persistent and widespread among developing countries
    • Linked to AS (volatile inflation & stable RER)
    • Greater sensitivity of money demand, slower and more volatile growth, greater financial fragility
    • No significant gains in terms of domestic financial depth (no impact of restrictions on FD)
fd where do we go from here
FD: Where do we go from here?
  • Two-way approach: Prudential regulation (stick) & promotion of peso instruments (carrot)
  • Latam experiences:
    • Chile (indexation)
    • Mexico (restrictions & local currency bond markets)
    • Uruguay (prudential regulation & indexation)
    • Argentina (restrictions on FD & indexation)
  • Ultimately, a“fear vs. greed” dilemma?
  • Rol of IFIs?
financial d o llarization eduardo levy yeyati universidad torcuato di tella16

Financial DollarizationEduardo Levy YeyatiUniversidad Torcuato Di Tella

Presentation at the Office of the Chief Economist

Inter American Development Bank

November 2, 2004

weak currency problem
Weak Currency Problem
  • Weak currency: Not accepted either internationally or domestically as a reliable store of value (De la Torre et al., 2002)
    • Shortermism in the local currency
      • Duration mismatch  Roll-over risk
      • Floating rates, CPI indexation
    • Dollar indexation (FD)  Currency risk
d eposit d ollarization
Deposit dollarization

Dollar Deposits over Total Deposits

Time deposits

Savings deposits

Demand deposits

Source: De la Torre, Levy Yeyati and Schmukler (2002).

real c ash in c irculation
Real cash in circulation

Includes quasi-monies.

Source: De la Torre, Levy Yeyati and Schmukler (2002).

rer exposure
RER Exposure
  • FD & Original sin
    • Eichengreen et al. (2003): Only external mismatch is important, but...
    • ...currency balance is needed at the micro level (domestic longs & shorts do not cancel out in practice)
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