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Discussion Paper Details

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Title: Dollarization, Bailouts and the Stability of the Banking System

Author(s): Douglas M Gale and Xavier Vives

Publication Date: July 2001

Keyword(s): banking crisis, IMF, lender of last resort, liquidity and moral hazard

Programme Area(s): Financial Economics and International Macroeconomics

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.

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Bibliographic Reference

Gale, D and Vives, X. 2001. 'Dollarization, Bailouts and the Stability of the Banking System'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=2901