The Choice of Exchange Rate Regime and Monetary Target in Highly Dollarized Economies

Abstract

We examine the implications of high degrees of dollarization for the choice of exchange rate regime and the information content of various monetary aggregates in developing countries. We conclude that a high degree of currency substitution argues for a more fixed exchange rate regime, while asset substitution may imply that either more rigid or more flexible regimes may be appropriate. We also ask whether the most informative monetary aggregates include dollar assets. Based on an analysis of five countries, we conclude inter alia that broader aggregates that include dollar assets perform better than those that do not.

Keywords: Dollarization, currency substitution, exchange rates, financial programming, money demand

JEL Classification: E51, E52, E58, F31, F36, F41