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Debate: Dollarization

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Should countries change their official currency to the U.S. dollar?


Background and Context of Debate:

Official dollarization involves a country abandoning an independent currency. In dollarized countries, only a foreign currency is legal tender (though local coins may be produced). Dollarization usually involves the US dollar, but may increasingly refer to conversion to other currencies such as the Euro. Panama, Ecuador and El Salvador are all currently "dollarized", as are many small countries including East Timor, and dollarization was seriously suggested as a solution to Argentina’s recent crisis. Dollarization is different from monetary union because the US continues to set monetary policy in its own interest alone, whereas the European Central Bank (for example) is required to take all Eurozone countries’ interests into account.

Avoiding financial crises: Can dollarization help countries avoid financial crisis?


Argument:Full dollarization can protect countries from currency crises. The Argentine and East Asian crises showed that partially fixed exchange rates expose countries to the risk of sharp falls in the exchange rate when speculators attack. Under dollarization there is no exchange rate to be attacked, so speculators have no role.[1]


Currency crises can be better avoided under floating exchange rates. If the government does not try to fix the exchange rate, then the rate will constantly adjust, with gradual falls instead of sharp crises.[2]

Fighting Inflation: Does dollarization decrease the risk of inflation?


Dollarization reduces the risk of inflation: Governments, especially in developing countries, are very bad at controlling inflation. They always want to increase short term growth at the expense of long term stability. Governments should tie their own hands through dollarization to make their anti-inflation rhetoric credible.[3]

Lowered inflation risks encourages investment: The fear of high inflation is a major factor inhibiting investment in developing countries. By dollarizing, these fears can be settled, and investments are likely to flow more freely.[4]


Other methods are available to limit inflationary tendencies: Independent central banks are widely used in the developed world, and can work for developing countries if effort is put in to designing the institutions correctly. It is ridiculous to suggest governments should restrict their own ability to help their economies, just because some governments have sometimes misused this power.[5]

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Monetary policy: Does dollarization, and the sacrifice of a country's independent monetary policies, have significant consequences?


Monetary policy is not actually very useful: Countries are just as likely to abuse it and cause high inflation as they are likely to use it correctly. Developing countries never truly have independent monetary policy anyway, their economies are heavily affected by the United States’ policies even without dollarization, since changes in the US interest rate change demand for their exports.[6]


By losing the ability to set interest rates, governments lose the ability to help their country in a recession: When times are bad, they are unable to devalue their currency in order to increase demand and encourage recovery. Monetary policy is a key tool for managing your economy, and giving it up exposes countries to economic slumps that cannot be corrected. And, unlike in a currency union, the US sets monetary policy for its currency with complete disregard for the interests of dollarized countries, opening the potential that the exact wrong measures will be taken for a dollarized country in recession.[7]


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