Chapter 14: Problem 3

Why do some developing countries adopt currency boards? Why do others dollarize their monetary systems?

Short Answer

Expert verified

Some developing countries adopt currency boards or dollarize their monetary systems to provide economic stability by pegging their economies to a more stable foreign currency. Often, this can increase international trade and investment. The choice between adopting a currency board and dollarizing can be influenced by factors such as the stability of the national currency, economic conditions, trade relationships, and political factors.

Step by step solution

Understand Currency Boards

A currency board is a monetary authority which commits to exchanging its own currency at a fixed rate with a foreign 'anchor' currency. This system can provide economic stability, as the value of the national currency is directly linked to a more stable foreign currency. This stability can attract international investment and lower inflation. However, a currency board limits a country's monetary independence as changes in the anchor currency's value will directly affect the country's economy.

Understand Dollarization

Dollarization occurs when a country chooses to use a foreign currency, such as the U.S. dollar, in parallel to or instead of its own national currency. This provides stability and can increase international trade and investment. However, this means the country gives up the ability to implement its own monetary policy and must accept the monetary policy of the foreign currency's country. Moreover, seignorage profit goes to the country of the foreign currency.

Decision Factors

Factors influencing the decision to adopt a currency board or dollarize include the stability and strength of the country's own currency, the state of its economy (especially inflation rates), its trading patterns, and political factors such as relationships with the foreign currency's country.

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Why do some developing countries adopt currency boards? Why do others dollarize their monetary systems?

Short Answer

Step by step solution

Understand Currency Boards

Understand Dollarization

Decision Factors

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