DP2412 | Should Argentina Adopt The US Dollar?

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A popular suggestion among emerging or transition economies is to 'dollarize' or 'euro-ize'; that is to adopt the currency of a larger, richer neighbour in order to import the monetary discipline and financial stability of that neighbour. This paper examines the pros and cons of that suggestion in Argentina, where it has become a serious political concern. We argue that the usual Optimal Currency Area criteria, while important, may not be the dominant consideration where a currency board, or where exchange rate fixing or stabilization, is the natural alternative. This is because such a fixing arrangement creates risk premia against the possibility that the exchange rate parity cannot be maintained, and against the possibility that the domestic economy will be unable or unwilling to fund the bonds, securities or reserves used to back the domestic currency issue. We find the growth and investment benefits of removing the risk premia outweigh any optimal currency area difficulties. But that produces its own difficulties in that there may be a conflict between the need to develop an economy's real side, which depends on the optimal currency area criteria, and the conditions of financial stability needed to realize that developments depend on the discipline effects from outside that currency area.