DP2901 Dollarization, Bailouts and the Stability of the Banking System
|Author(s):||Douglas M Gale, Xavier Vives|
|Publication Date:||July 2001|
|Keyword(s):||banking crisis, IMF, lender of last resort, liquidity, moral hazard|
|JEL(s):||E58, F30, G28|
|Programme Areas:||International Macroeconomics, Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=2901|
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.