Dollarization, Bailouts and the Stability of the Banking System

48 Pages Posted: 28 Aug 2001

See all articles by Douglas M. Gale

Douglas M. Gale

New York University (NYU) - Department of Economics

Xavier Vives

University of Navarra - IESE Business School; Universitat Pompeu Fabra (UPF); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2001

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 preferable 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. A very severe moral hazard problem could make dollarization undesirable, however. 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.

Keywords: Moral hazard, banking crisis, lender of last esort, liquidity, IMF

JEL Classification: E58, F30, G28

Suggested Citation

Gale, Douglas M. and Vives, Xavier, Dollarization, Bailouts and the Stability of the Banking System (July 2001). CEPR Discussion Paper No. 2901. Available at SSRN: https://ssrn.com/abstract=281508

Douglas M. Gale (Contact Author)

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

Xavier Vives

University of Navarra - IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

HOME PAGE: http://wwwapp.iese.edu/faculty/facultyDetail.asp?lang=en&prof=xv

Universitat Pompeu Fabra (UPF) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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