Currency Substitution And Dollarization

Along with the declaration of dollarization in Argentina, dollarization gradually becomes the government's active policy. And it makes currency substitution a focal point of world-wide debate again. Since 1970, many countries have experienced currency substitution, among which dollarization occurred in Latin is most typical. The dissertation is meant to be an analysis and empirical study on the phenomenon of "dollarization". Under the background of globlization and currency integration, we shall know about its causes, functional mechanism, economic influence and implications for macroeconomic policy as well. Based on the observations of situation in present China, we'll discuss our country's currency substitution in detail.The whole dissertation is organized as follows.The first chapter is an introduction to the background of dollarization, together with some well-defined terminologies as well.Chapter Two presents a historical analysis on the relationship between currency substitution and dollarization. All facts show a survey of the causes and foundations of dollarization, both theoretical and practical. It reveals that with the change of financial credit system and the globlization of world economy, such phenomenon will sooner or later be a certain tendency.Chapter Three illustrates dollarization from theoretical perspective. The existing literature has tried to explain conjectures about how dollarization may work . They consider it a kind of money demand for an open economy. Their analytical method issimilar--establishing a model including money demand function with a series ofrestrictions; then solving the equation to get the optimal quantity of money demand. Unfortunately, these thoeries have some important gaps, owing to their focal point varies from each other. However, there are also several points of agreement, which actually develop and perfect the whole theory system constantly.The effects of dollarization, as well as implication for policy are discussed in Chapter Four. As emphasized in the literature, dollarization means benefits and costs as well. It would prevent the implementation of a macroeconomic policy, such as exchange rate policy, monetary policy. This is because the exchange rate may be no longer serve as an adjustment tool, and in this respect, dollarization resembles an inevitably fixed exchange rate system. However, dollarization implies a further loss, namely that the stock of domestic base money would have to be retired from circulation and exchanged for dollars. In another words, the so called seigniorage would accrue to the US Federal Reserve, meanwhile, the inflation tax will alsodecrease as residents reduce their demands for domestic money. Consequently, thecore policy should be stability of macroeconomy-decreasing present highinflation; guaranteeing the real yield rate of domestic money; decreasing the internal impetus to substitute currency, etc. Among them, "No action" theory is prime essential.Finally, we shall describe the similar phenomenon in China. On account of the exchange control over capital flows, the ratio of foreign deposit to broad-defined money is so low, compared with that of Latin countries. However, from other economic variables, such as exchange rate, interest rate and inflation rate, exp capital flight, we can easily see that underground currency substitution is existed. Therefore, we can resort to the stable macroeconomic polices, esp liberation of interest rate, to avoid side-effects of currency substitution.