Stabilization Policy and the Costs of Dollarization

28 Pages Posted: 9 Aug 2000

See all articles by Stephanie Schmitt-Grohé

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: May 31, 2000

Abstract

This paper compares the welfare costs of business cycles in a dollarized economy to those arising in economies with different monetary arrangements. The alternative monetary policy regimes studied belong to three broad families: devaluation rate rules, inflation targeting, and money growth rate rules. The analysis is conducted within an optimizing model of a small open economy with sticky prices. The model is calibrated to the Mexican economy and is driven by three external shocks: terms of trade, world interest rate, and import-price inflation. We show econometrically that these shocks explain at a minimum 45 percent of the observed forecasting error variance of Mexican output and the Mexican real exchange rate at 8- to 16-quarter horizons. The model fits the data relatively well in the sense that it can account for the volatility and comovements of key macroeconomic indicators such as output, consumption, inflation, and the real exchange rate. The welfare comparisons suggest that dollarization is the least successful of the monetary policy rules considered: agents are willing to give up between 0.1 and 0.3 percent of their nonstochastic steady-state consumption to see a policy other than dollarization implemented.

Suggested Citation

Schmitt-Grohe, Stephanie and Uribe, Martin, Stabilization Policy and the Costs of Dollarization (May 31, 2000). Available at SSRN: https://ssrn.com/abstract=224056 or http://dx.doi.org/10.2139/ssrn.224056

Stephanie Schmitt-Grohe

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Martin Uribe (Contact Author)

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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212-851-4008 (Phone)
212-854-8059 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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