20240620-IMF-Escaping_the_Financial_Dollarization_Trap_The_Role_of_Foreign_Exchange_Intervention_39页_1mb

Escaping the Financial Dollarization Trap: The Role of Foreign Exchange Intervention

This working paper examines how financial dollarization—private sector borrowing in foreign currency—constrains monetary policy and increases macroeconomic volatility in emerging economies. It argues that foreign exchange intervention can mitigate these effects.

Key Findings:

1. Balance Sheet Effects: Capital outflows worsen financial dollarization, raising borrowing costs and reducing investment due to balance sheet losses, limiting policy tools.
2. Role of Intervention: Sterilized foreign exchange intervention successfully stabilizes output and exchange rates by curbing balance sheet risks. An optimal policy can offset dollarization’s volatility.
3. Policy Dilemma: Combining foreign exchange intervention with monetary policy allows central banks to stabilize the economy, addressing the “dollarization trap.”

Implications:

• Foreign exchange reserves can improve welfare and reduce macroeconomic volatility in dollarized economies.
• Effective intervention supports monetary policy autonomy, enabling counter-cyclical tools during external shocks.

This research rationalizes low volatility in some dollarized countries and advocates for strategic reserve deployment.