n AfricaGrowth Agenda - The pros and cons of dollarization

Volume 2010, Issue 7
  • ISSN : 1811-5187


In high inflation countries foreign currency has been used first as a store of value at first and later as a medium of exchange. Calvo and Vegh (1992) view that currency substitution is normally the last stage of the dollarization process. A number of developing countries have resorted to dollarization as a short-term stabilization objective. What remains clear are the conditions that normally lead to dollarization which have traditionally been similar from a number of different countries. Financial liberilation usually opens the economy the global financial market. Economic agents are free to hold foreign currency accounts. The moment prices keep rising it prompts agents to quote prices in foreign currency as a way to maintain value. If restrictions are not strong enough a large outflow of funds are transferred outside the economy and this coupled with the high foreign currency demand slides the economy into semi-dollarized state. The moment the local currency seizes to be acceptable as a medium of exchange then policy makers have no option but to officialize dollarization.

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