The Financial Risks of Monetary Regimes
The Financial Risks of Monetary Regimes
This chapter analyzes the financial risks of monetary regimes. The focus is on risks posed by regimes based on local currencies exclusively; risks subject to spontaneous dollarization; and the risks posed by formal dollarization. The chapter shows that the risks of fully dollarized economies are less numerous and are lower than those of the other two categories, with one single exception: international withdrawals, which only applies when the country is a regional financial center with highly correlated risks. It suggests that the financial advantages of the formally dollarized economy stem from two fundamental properties of international currencies. First, they minimize the risk of dilution, and such minimization is crucial. All other risks of the local currencies are related to this risk. Second, the dollarized regime is the only one that can conceivably operate with just one currency—inside and outside its borders—thus eliminating the currency risk altogether.
Keywords: monetary regimes, local currencies, dollarized economies, financial center, currency risk
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