Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364



Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

Can you think of any major disadvantages to dollarization? How would a central bank work in a country that has dollarized?

To determine

The major disadvantages to dollarization and the way central bank works in a dollarized country.


Dollarization is the phenomenon where a country uses the currency of another country in addition to or in place of its own currency. For example, British Virgin Islands, Caribbean Netherlands, East Timor, etc. use US dollar as their currency. And, Cambodia, Iraq and Uruguay use both US dollar and their own currencies as the legal tender.

When a nation dollarizes, i.e. adopts the currency of another nation, the disadvantages are as follows. A major disadvantage to a dollarizing country is that the country loses autonomy over its monetary policy which is central bank’s tool to control money supply, inflation and interest rates in the economy. Also, the dollarizing country faces loss of seigniorage (Seigniorage is the real revenue from printing money. It is used to finance fiscal deficit).Apart from this, price signals through domestic currency are distorted. The country replacing its currency with the other faces the risk of its central bank losing the identity as the lender of the last resort...

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