Skip to main content
SpringerLink
Log in

Was Unofficial Dollarisation/Euroisation an Amplifier of the ‘Great Recession’ of 2007–2009 in Emerging Economies?

  • Symposium Article
  • Published:
Comparative Economic Studies Aims and scope Submit manuscript

Abstract

This paper investigates whether, and if so why, the recent ‘Great Recession’ was more severe in unofficially dollarised/euroised economies than in other economies. To that end, the paper builds on a novel data set on unofficial dollarisation/euroisation to test whether the latter was a determinant of the extent of the growth collapse in 2007–2009 in a cross-section of around 60 emerging market economies. Both OLS and Bayesian model averaging estimates suggest that unofficial dollarisation/euroisation was an important contributor to the severity of the crisis, once other of its well-established determinants are taken into account, including fast pre-crisis credit growth, current account deficits, trade and financial openness, market regulation, international openness of the banking sector and GDP per capita. Moreover, the adverse impact of unofficial dollarisation/euroisation is found to have been transmitted through the main channels traditionally highlighted in the literature, that is, currency mismatches, reduced monetary policy autonomy and limited lender of last resort ability, all of which became more binding constraints in the midst of the crisis. Overall, the results underline the need for stronger macro-prudential surveillance of developments in foreign currency lending in emerging economies. They also allow shedding new light on the long-standing debate regarding the optimal conduct of monetary policy in unofficially dollarised/euroised economies in crisis times.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Figure 1
Figure 2
Figure 3
Figure 4
Figure 5
Figure 6
Figure 7

Similar content being viewed by others

Notes

  1. Rose and Spiegel (2009a, 2009b and 2011) conducted an extensive investigation of more than 100 potential determinants that could help explain the cross-country crisis incidence and found few clear reliable indicators in the pre-crisis data.

  2. For instance, Aghion et al. (2000 and 2001), Balino et al. (1999), Céspedes et al. (2004), Reinhart et al. (2003), among many others, study how dollarisation can affect optimal monetary policy. There is also a literature that studies how monetary policy can affect the currency composition of corporate debt (see eg Jeanne, 2003). Eichengreen and Hausmann (1999 and 2005) analyse the external vulnerability arising from foreign currency-denominated external debt, introducing the concept of the ‘original sin’.

  3. Their analysis suggests that it was not flexible exchange rates alone that were able to rule out bank runs, but the coupling of exchange rate flexibility with a lender of last resort. This gives therefore support to the view that unofficial dollarisation (independently of the exchange rate regime) may be destabilising, as it prevents the central bank from serving as a lender of last resort, thereby wiping out the potential benefits of flexible exchange rates.

  4. See also Bussière et al. (2010) and Giannone et al. (2011) for further practical applications.

  5. It is important to stress that in this second step we are less interested in the total effect of loan dollarisation per se (already estimated in the first step) or in the total effect of each of the three channels per se. We are particularly interested in how the two play out with each other to capture the transmission of the costs of dollarisation/euroisation to the real economy. We are therefore mainly interested in their interacted effect.

  6. Arguably, the IMF has recently started to collect data on foreign-currency loans in the framework of the Financial Soundness Indicators (FSI) database; the ratios of foreign-currency loans to total loans are however part of the ‘Encouraged FSI’, not of the ‘Core FSI’, and therefore are reported only for a limited number of countries.

  7. See Rancière et al., 2010a, 2010b for details on a new index of currency mismatch measurement, which takes into account unhedged borrowers.

  8. The chart displays the actual values of pre-crisis loan dollarisation and the change in the real GDP growth rates during the crisis, together with their conditional relation which controls for the core variables included in the baseline regression.

  9. For instance, Dedola and Lombardo (2012) develop a model of financial integration and present simulation results that indicate that an unexpected increase in credit spreads in one country generates a similar increase in credit spreads in other financially integrated countries bringing about a global contraction, quite independently of the exposure to foreign assets in the balance sheet of leveraged investors. In a related vein, Devereux and Yetman (2010) develop a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors, while Mendoza and Quadrini (2010) suggest that financial globalization played an important role in the recent financial crisis, showing that financial integration leads to a sharp rise in net credit in the most financially developed country and to large asset price spillovers of country-specific shocks to bank capital.

  10. They found that ‘once we control for GDP per capita and the current account, there is no evidence that financial openness (the size of the external balance sheet) is associated with lower growth during the crisis. Indeed, this variable is significant only in column (3) and it enters with a positive sign in that case’, and that ‘higher trade openness is negatively correlated with output performance during the crisis, but the partial correlation is not statistically significant’ (Lane and Milesi-Ferretti, 2010, p. 21).

  11. Bayesian estimates indicate therefore that growth declined by almost 0.5% point more in countries where loan dollarisation was 10% points higher. The elasticity is therefore almost identical with that obtained when using OLS on the full country sample, further strengthening our central findings.

  12. The full set of results is not reported here, but is available upon request.

  13. The results are not reported here for the sake of conciseness, but are available upon request.

  14. See, for example, Krugman (1999), Chang and Velasco (2000a, 2000b), Furman and Stiglitz (1998), Allen et al. (2002), Bordo and Meissner (2005 and 2007), Céspedes et al. (2004) or Rancière et al. (2010a, 2010b), who recall the key role played by balance sheet vulnerabilities, for instance in Mexico's crisis of 1994 or in the East Asian crisis of 1997–1998.

  15. Admittedly, a more careful analysis might be warranted to understand the ‘Fischer effect’ better, such as by distinguishing between different exchange rate regimes and degrees of financial openness, in line with the standard Mundell–Fleming ‘impossible trinity’. However, this would stretch far beyond the scope of the present paper, not least due to the limited number of observations and hence of degrees of freedom available for such a particular setup. We therefore leave this extension for further research.

  16. As a further robustness check, we also centred the variables entering the interactions. Expectedly, the slope of the interaction term remains the same whether or not the main effects are centred, while only the coefficients of the main effects and the intercept change. Given that for our purpose we are only interested in the coefficient of the interaction term, centring the main effects variables has no implication for the economic interpretation discussed above.

References

  • Aghion, P, Bacchetta, P and Banerjee, A . (2000): A simple model of monetary policy and currency crises. European Economic Review, Elsevier, 44 (4–6): 728–738.

    Google Scholar 

  • Aghion, P, Bacchetta, P and Banerjee, A . (2001): Currency crises and monetary policy in an economy with credit constraints. European Economic Review, Elsevier, 45 (7): 1121–1150.

    Google Scholar 

  • Allen, M, Rosenberg, C, Keller, C, Setser, B and Roubini, N . (2002): A balance sheet approach to financial crisis IMF Working Paper, No. 02/210.

  • Arteta, C . (2003a): Are financially dollarized countries more prone to costly crises? International Finance Discussion Papers, No. 763, Board of Governors of the Federal Reserve System.

  • Arteta, C . (2003b): Exchange rate regimes and financial dollarization: Does flexibility reduce bank currency mismatches? International Finance 0303005, EconWPA.

  • Balino, T, Bennett, A and Borensztein, E . (1999): Monetary policy in dollarised economies, IMF Occasional Paper, No. 171.

  • Bekaert, G, Ehrmann, M, Fratzscher, M and Mehl, A . (2011): Global crises and equity market contagion. NBER Working Paper, No. 17121.

  • Berglöf, E, Korniyenko, Y, Plekhanov, A and Zettelmeyer, J . (2009): Understanding the crisis in emerging Europe. EBRD Working Paper, No. 108.

  • Berkmen, P and Cavallo, E . (2009): Exchange rate policy and liability dollarization: What do the data reveal about causality? IMF Working Paper, No. 07/33.

  • Berkmen, P, Gelos, G, Rennhack, R and Walsh, J . (2009): The global financial crisis: Explaining cross-country differences in the output impact. IMF Working Paper, No. 280.

  • Blanchard, O, Das, M and Faruquee, H . (2010): The initial impact of the crisis on emerging market countries. Brookings Paper on Economic Activity spring 2010: 263–307.

  • Bordo, M and Meissner, C . (2005): The role of foreign currency debt in financial crises: 1880–1913 vs. 1972–1997. NBER Working Paper No. 11897.

  • Bordo, M and Meissner, C . (2007): Financial crises, 1880–1913: The role of foreign currency debt. NBER Chapters, In: Edwards, S, Esquivel, G and Márquez, G (eds). The Decline of Latin American Economies: Growth, Institutions, and Crises, pp. 139–194, University of Chicago Press.

  • Bordo, M, Meissner, C and Stuckler, D . (2009): Foreign currency debt, financial crises and economic growth: A long run view. NBER Working Paper No. 15534, November 2009.

  • Broda, C and Levy Yeyati, E . (2006): Endogenous deposit dollarization. Journal of Money, Credit and Banking 38 (4): 963–988.

    Article  Google Scholar 

  • Bussière, M and Fratzscher, M . (2006): Towards a new early warning system of financial crises. Journal of International Money and Finance 25 (6): 953–973.

    Article  Google Scholar 

  • Bussière, M, Ca’Zorzi, M, Chudik, A and Dieppe, A . (2010): Methodological advances in the assessment of equilibrium exchange rates. ECB Working Paper, No. 1151, January 2010.

  • Bussière, M, Fratzscher, M and Koeniger, W . (2004): Currency mismatch, uncertainty and debt maturity structure. ECB Working Paper, No 409, November 2004.

  • Calvo, G . (2006): Monetary policy challenges in emerging markets: Sudden stop, liability dollarization, and lender of last resort. NBER Working Paper, No. 12788, December 2006.

  • Céspedes, LF, Chang, R and Velasco, A . (2004): Balance sheets and exchange rate policy. American Economic Review 94 (4): 1183–1193.

    Article  Google Scholar 

  • Chang, R and Velasco, A . (2000a): Financial fragility and the exchange rate regime. Journal of Economic Theory 92 (1): 1–34.

    Article  Google Scholar 

  • Chang, R and Velasco, A . (2000b): Liquidity crises in emerging markets: Theory and policy. NBER Chapters, In: Bernanke, B and Rotemberg, J (eds). NBER Macroeconomics Annual 1999, Volume 14, pp. 11–78, MIT Press: National Bureau of Economic Research.

  • Chang, R and Velasco, A . (2002): Dollarization – Analytical issues. NBER Working Paper, No. 8838.

  • Claessens, S, Dell’Ariccia, G, Igan, D and Laeven, L . (2010): Cross-country experiences and policy implications from the global financial crisis. Economic Policy 25 (62): 269–293.

    Article  Google Scholar 

  • De Nicoló, G, Honohan, P and Ize, A . (2003): Dollarisation of the banking system: Good or bad? IMF Working Paper, No. 146.

  • Dedola, L and Lombardo, G . (2012): Financial frictions, financial integration and the international propagation of shocks. Economic Policy 27 (70): 319–359.

    Article  Google Scholar 

  • Devereux, M and Yetman, J . (2010): Leverage constraints and the international transmission of shocks. Journal of Money, Credit and Banking 42 (s1): 71–105.

    Article  Google Scholar 

  • Eichengreen, B and Hausmann, R . (1999): Exchange rates and financial fragility. NBER Working Paper, No. 7418.

  • Eichengreen, B and Hausmann, R . (2005): Other people's money – Debt denomination and financial instability in emerging market economies. The University of Chicago Press: Chicago.

    Book  Google Scholar 

  • Eichengreen, B, Rose, A and Wyplosz, C . (1996): Contagious currency crises. NBER Working Paper, No. 5681.

  • Fischer, S . (1998): The Asian crisis: A view from the IMF. (Address at) Midwinter Conference of the Bankers’ Association for Foreign Trade.

  • Frankel, J and Saravelos, G . (2010): Are leading indicators of financial crises useful for assessing country vulnerability? Evidence from the 2008–2009 Global Crisis. NBER Working Paper No. 16047, June.

  • Furman, J and Stiglitz, J . (1998): Economic crises: Evidence and insights from East Asia. Brookings Papers on Economic Activity 1998 (2): 1–114.

    Article  Google Scholar 

  • Giannone, D, Lenza, M and Reichlin, L . (2011): Market freedom and the global recession. IMF Economic Review 59 (1): 111–135.

    Article  Google Scholar 

  • Goldstein, M and Turner, P . (2004): Controlling currency mismatches in emerging markets. Institute for International Economics: Washington DC.

    Google Scholar 

  • Gulde, A-M, Hoelscher, D, Ize, A, Marston, D and De Nicolo, G . (2004): Financial stability in dollarised economies IMF Occasional Paper, No. 230.

  • Honohan, P and Shi, A . (2001): Deposit dollarisation and the financial sector in emerging economies. World Bank Policy Research Working Paper, No. 2748.

  • Ilzetzki, E, Reinhart, C and Rogoff, K . (2008): Exchange rate arrangements into the 21st century: Will the anchor currency hold?. mimeo (University of Maryland and Harvard University).

  • International Monetary Fund. (2010a): How did emerging markets cope in the crisis? International Monetary Fund Policy Paper, Washington DC.

  • International Monetary Fund. (2010b): World Economic Outlook Report, April 2010.

  • Jeanne, O . (2003): Why do emerging economies borrow in foreign currency? CEPR Discussion Papers.

  • Jeanne, O and Wyplosz, C . (2003): The international lender of last resort. How large is large enough? NBER Chapters In: Dooley, M and Frankel, J (eds). Managing Currency Crises in Emerging Markets, National Bureau of Economic Research: University of Chicago Press, pp.89–124.

    Chapter  Google Scholar 

  • Kaminsky, G and Reinhart, C . (2000): On crises, contagion, and confusion. Journal of International Economics 51 (1): 145–168.

    Article  Google Scholar 

  • Krugman, P . (1999): Balance sheets, the transfer problem and financial crises. International Tax and Public Finance 6 (4): 459–472.

    Article  Google Scholar 

  • Lane, PR and Milesi-Ferretti, GM . (2010): The cross-country incidence of the global crisis. CEPR Discussion Paper, No. 7954.

  • Lindgren, C-J, Baliño, T, Enoch, C, Gulde, A-M, Quintyn, M and Teo, L (1999): Financial sector crisis and restructuring: Lessons from Asia. IMF Occasional Paper, No. 188.

  • Levy Yeyati, E . (2006): Financial dollarization: Evaluating the consequences. Economic Policy, CEPR, CES, MSH 21 (45): 61–118.

    Google Scholar 

  • Levy Yeyati, E and Sturzenegger, F . (2003): Dollarisation – Debates and policy alternatives. MIT Press: Cambridge, MA.

    Google Scholar 

  • Mendoza, E and Quadrini, V . (2010): Financial globalization, financial crises and contagion. Journal of Monetary Economics 57 (1): 24–39.

    Article  Google Scholar 

  • Obstfeld, M, Shambaugh, J and Taylor, A . (2009): Financial instability, reserves, and central bank swap lines in the panic of 2008. American Economic Review 99 (2): 480–486.

    Article  Google Scholar 

  • Rancière, R, Tornell, A and Vamvakidis, A . (2010a): A new index of currency mismatch and systemic risk. IMF Working Paper, No. 10/263, Washington DC.

  • Rancière, R, Tornell, A and Vamvakidis, A . (2010b): Currency mismatch, systemic risk and growth in emerging Europe. Economic Policy 25 (64): 597–658.

    Article  Google Scholar 

  • Reinhart, C, Rogoff, K and Savastano, M . (2003): Addicted to dollars. NBER Working Paper Series, No. 10015, October 2003.

  • Rose, A and Spiegel, M . (2009a): Cross-country causes and consequences of the 2008 crisis: International linkages and American exposure. NBER Working Paper, No. 15358.

  • Rose, A and Spiegel, M . (2009b): Cross-country causes and consequences of the 2008 crisis: Early warning’. NBER Working Paper, No. 15357.

  • Rose, A and Spiegel, M . (2011): Cross-country causes and consequences of the crisis: An update. European Economic Review 55 (3): 309–324.

    Article  Google Scholar 

  • Sala-i-Martin, X, Doppelhofer, G and Miller, RI . (2004): Determinants of long-term growth: A Bayesian averaging of classical estimates (bace) approach. American Economic Review 94 (4): 813–835.

    Article  Google Scholar 

  • Stiglitz, J . (2002): Globalization and its discontents. W.W. Norton: New York.

    Google Scholar 

  • Zettelmeyer, J . (2010): Should governments regulate away foreign exchange lending? EBRD (website).

  • Zettelmeyer, J, Nagy, P and Jeffrey, S . (2010): Addressing private sector currency mismatches in emerging Europe. EBRD Working Paper, No. 115.

Download references

Acknowledgements

I am particularly indebted to Alexander Chudik for sharing his MatLab code for the BACE estimates. I am also grateful for helpful suggestions, comments and discussions to Thierry Bracke, Matthieu Bussière, Alexandra Coiculescu, Olivier Jeanne, Ricardo Lago, Hélène Rey, Livio Stracca, Marco Lo Duca and Adalbert Winkler, as well as to the members of the International Relations Committee and to participants in an ECB internal seminar, at the Infinity Conference Dublin, 11–12 June 2012, at the Dubrovnik Economic Conference, 27–29 June 2012 and at the European Economic Association Conference, 27–31 August 2012. I would also like to thank two anonymous referees for very helpful suggestions and comments. The paper has received the 2012 CFA Romania Award (macroeconomics section). The views expressed therein are those of the author and do not necessarily reflect those of the European Central Bank or the Eurosystem.

Author information

Authors and Affiliations

  1. European Central Bank, Kaiserstrasse 29, Frankfurt am Main, D-60311, Germany

    Livia Chiţu

Authors
  1. Livia Chiţu
    View author publications

    You can also search for this author in PubMed Google Scholar

Rights and permissions

Reprints and permissions

About this article

Cite this article

Chiţu, L. Was Unofficial Dollarisation/Euroisation an Amplifier of the ‘Great Recession’ of 2007–2009 in Emerging Economies?. Comp Econ Stud 55, 233–265 (2013). https://doi.org/10.1057/ces.2013.1

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/ces.2013.1

Keywords

JEL Classifications

Search

Navigation