Dollarization, Bailouts and the Stability of the Banking System
48 Pages Posted: 28 Aug 2001
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Dollarization, Bailouts, and the Stability of the Banking System
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: Suggested Citation
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