Basil wrote:
William
Does everyone in the Dollarisation debate recognize that once a country
dollarises, it ceases to have any balance of payments problems with all
countries who are also on the dollar? The current account deficit ceases to
matter, and is no longer a constraint. eg like New England with the rest of
the country.
My response:
Basil, I do not see why this is so. What am I missing? First, let us define
what we mean by "dollarization". There are many steps along the road,
starting with a currency board backed by a dollar reserve or simply massive
substitution of dollar holdings by the citizens of a foreign country as
opposed to their domestic currency. Or, we could go all the way to
dollarization where the actual currency becomes the dollar.
It is still possible for this country to have a current account deficit, and
it is still possible to have a capital account deficit. Since you cannot
adjust the exchange rate, you must adjust by reducing the amount of domestic
currency in circulation. Of course, this means that if you include foreign
exchange transactions by the monetary authority/central bank as a balancing
item in the Balance of Payments, it will sum to zero. But I took you to
mean something stronger-that net inflows of money into the country will sum
to zero without the balancing.
In the final case all it will mean is that all transactions are denominated
in dollars. But why would the current account or the capital account
necessarily sum to zero without balancing by the monetary authority? I see
no reason why this HAS to be true.
This is hugely important for developing countries. In SA, where I am
currently residing, whenever the economy grows rapidly, its MPM capital
goods is about 1, so capital imports flood in, the current account goes
into deficit, and the CB must dramatically raise interest rates to protect
the exchange rate, so the boom and growth is flattened.
So is your argument then that income must adjust to create BOP equality?
What is the benefit of this?