Dollarization

by on March 19, 2007 at 7:20 am in Economics | Permalink

Tyler suggests that dollarization raises prices.  I am in Panama investigating.  It´s true that the price of goods here, with the exception of some labor intensive goods like food preparation and taxi service, is similar to the U.S.  Despite Tyler´s recondite arguments, however, I think dollarization lowers not raises real prices.

The argument to the contrary is mostly an illusion.  When there is an exchange rate the nominal exchange rate can depart far from the real exchange rate.  Over a matter of months a country can become very cheap or very expensive for tourists.  The real exchange rate, however, is much more stable than the nominal exchange rate.  So when dollarization fixes the nominal exchange rate a country is unlikely to become either very cheap or very expensive.  Add in the selection argument that tourists visit when the country is cheap and its easy to see why it might appear that dollarization raises prices.  (and for residents there is a selection effect also, dollarization happens when the country has been pushed to the wall.)

Overall, however, currency is mostly neutral and in the case of dollarization the effects if anything will be positive.  For a country like El Salvador or Panama dollarization brings lower transaction costs and higher quality money which lowers real prices.

Addendum:  Tyler, however, is correct about numero 6.

Tyler Cowen March 19, 2007 at 7:51 am

I bet a haircut costs more there than in Mexico…is that wrong? It is true that dollarization raises output, in the long run, but don’t labor-intensive services become more expensive, as the Balassa theorem suggests?

Kurt Schuler March 19, 2007 at 12:44 pm

Here’s a way to reconcile Tyler and Anon’s posts: Dollarization can raise ground rents by increasing the capitalized value of land. By reducing the risks of high inflation and currency depreciation, dollarization makes it easier for financial institutions to offer long-term mortgages at fixed rates, which broadens the class of borrowers. More borrowers mean more demand for property, translating to higer selling prices, higher rents, and higher prices for nontradables than would otherwise exist.

Of course, this chain of reasoning is abstract; it would require empirical investigation to determine how significant dollarization is for property prices in fact.

Jessica March 19, 2007 at 11:21 pm

This article describes how dollarization in
third world countries is either rising or reducing
prices in these countries. With dollarization,
supply in demand for the country’s currency no
longer is taken into consideration. Instead it is
pegged to the United States currency, reducing
exchange rate fees. This can be either good or bad
for the economy of these countries that are becoming\
dollarized because the country can become very cheap
nor very expensive.

bobby March 24, 2007 at 2:52 pm
wslmwps August 21, 2007 at 1:26 am

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