Dollarization : A Literature Review of Developing Countries

While de-facto dollarization is not a new phenomenon, official dollarization is a novel development in monetary policy gaining momentum in many develop-ing countries. This paper reviews the literature on the rationale for dollariza-tion in developing countries; the empirical evidence lending support to the macroeconomic success of official dollarization; and the possibility of de-dollarizing economies which have been dollarized de-facto. It follows that the rationale for dollarization in developing countries is a conglomeration of as-sumptions which have no foundation in macroeconomic theory. Empirical ev-idence is neither suggestive nor conclusive of the macroeconomic success of officially dollarized countries. Forceful mechanisms to de-dollarize economies in developing countries have been met with undesirable economic and political outcomes. While market-driven mechanisms have somewhat proven to be suc-cessful, they require very long periods of negotiating policy credibility buy-backs and very high adjustment costs. Relevance to Development Studies Monetary policy is central to almost all countries economic growth agenda. The types of currency arrangements in monetary policy have often been the subject of currency crisis. Currency crises have often culminated into pro-longed political crisis leading to a setback in economic development. The cur-rency crises in Indonesia and Ecuador are classic examples to reflect on. As several developing countries are beginning to embrace the idea of adopting currencies of large economies as a way to insulate against recurrent currency shocks, it is important that the implications for economic growth and devel-opment are known aforehand. This research, though inconclusive, lays ground for policy decisions on dollarization in developing countries.