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Dollarization, bailouts, and the stability of the banking system

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Central bank policy suffers from time-inconsistency when facing a banking crisis: a bailout is optimal ex post but ex ante it should be limited to control moral hazard. Dollarization provides a credible commitment not to help at the cost of not helping even when it would be ex ante optimal to do so. Dollarization is good when the costs of establishing a reputation for the central bank are high, monitoring effort by the banker is important in improving returns, and when the cost of liquidating projects is moderate. However, a very severe moral hazard problem could make dollarization undesirable. The results obtained are applied to assess the desirability of dollarization in a range of countries and the potential role of the IMF as International LOLR.

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en

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application/pdf

Resource resource URL

http://flora.insead.edu/fichiersti_wp/inseadwp2001/2001-81.pdf

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Copyright INSEAD. All rights reserved