Dollarization, bailouts, and the stability of the banking system

Douglas Gale, Xavier Vives

    Research output: Contribution to journalArticle

    Abstract

    Central bank policy suffers from time inconsistency when facing a banking crisis: a bailout is optimal ex post, but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is good when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. However, a very severe moral hazard problem could make dollarization undesirable. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR. We would never put ourselves in a position where we envisioned actions that we would take would be of assistance to the rest of the world but to the detriment of the United States. Alan Greenspan to a congressional panel in 1999 [IHT, January 19, 2000].

    Original languageEnglish (US)
    Pages (from-to)467-503
    Number of pages37
    JournalQuarterly Journal of Economics
    Volume117
    Issue number2
    DOIs
    Publication statusPublished - May 2002

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    ASJC Scopus subject areas

    • Economics and Econometrics

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