Dollarization and Seignorage: How Much is at Stake?

Abstract

When a government decides to dollarize its economy, that is, to replace the domestic currency with the U.S. dollar, it automatically ceases to collect the stream of seignorage revenue, which is instead redirected toward the U.S. government. A central issue in the debate about dollarization is the distribution of seignorage between U.S. and the economies that are considering the adoption of the dollar as the sole legal tender. A pre-requisite for designing meaningful seignorage sharing rules is to asses the amount of resources that are at stake. A common misconception is that the amount of seignorage income involved is simply equal to the interest income on the amount of foreign reserves required to exchange the entire domestic money supply for dollars. This way of measuring the loss of seignorage income is in general biased for it implicitly assumes no growth in monetary assets. In this note we show that this bias can lead to enormous underestimations of the amount of seignorage revenue lost by governments of countries that dollarize.

JEL Classification: F41