Costs and Benefits of Dollarization: Evidence from North, Central, and South America

This paper examines the macroeconomic costs and benefits of dollarization. Economic theory suggests that the main benefit is enhanced price stability, while the main cost is higher business-cycle volatility if the dollarizing country’s output is not sufficiently correlated with that of the U.S. Data from 1950-1997 are used to estimate various cost and benefit measures for nineteen North, Central, and South American countries. The paper finds that these cost and benefit factors exhibit substantial variability across the countries considered. Furthermore, they are strongly positively correlated: countries (such as Peru) that have a lot to gain from dollarization, also have a lot to lose from it; while countries (such as Canada) that have little to lose by dollarizing, have also little to gain by it. The empirical results can be also used to compare net benefits for individual countries, showing, for example, that Chile is a better dollarization candidate than Mexico.