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Was Unofficial Dollarisation/Euroisation an Amplifier of the ‘Great Recession’ of 2007–2009 in Emerging Economies?


This paper investigates whether, and if so why, the recent ‘Great Recession’ was more severe in unofficially dollarised/euroised economies than in other economies. To that end, the paper builds on a novel data set on unofficial dollarisation/euroisation to test whether the latter was a determinant of the extent of the growth collapse in 2007–2009 in a cross-section of around 60 emerging market economies. Both OLS and Bayesian model averaging estimates suggest that unofficial dollarisation/euroisation was an important contributor to the severity of the crisis, once other of its well-established determinants are taken into account, including fast pre-crisis credit growth, current account deficits, trade and financial openness, market regulation, international openness of the banking sector and GDP per capita. Moreover, the adverse impact of unofficial dollarisation/euroisation is found to have been transmitted through the main channels traditionally highlighted in the literature, that is, currency mismatches, reduced monetary policy autonomy and limited lender of last resort ability, all of which became more binding constraints in the midst of the crisis. Overall, the results underline the need for stronger macro-prudential surveillance of developments in foreign currency lending in emerging economies. They also allow shedding new light on the long-standing debate regarding the optimal conduct of monetary policy in unofficially dollarised/euroised economies in crisis times.

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  1. Rose and Spiegel (2009a, 2009b and 2011) conducted an extensive investigation of more than 100 potential determinants that could help explain the cross-country crisis incidence and found few clear reliable indicators in the pre-crisis data.

  2. For instance, Aghion et al. (2000 and 2001), Balino et al. (1999), Céspedes et al. (2004), Reinhart et al. (2003), among many others, study how dollarisation can affect optimal monetary policy. There is also a literature that studies how monetary policy can affect the currency composition of corporate debt (see eg Jeanne, 2003). Eichengreen and Hausmann (1999 and 2005) analyse the external vulnerability arising from foreign currency-denominated external debt, introducing the concept of the ‘original sin’.

  3. Their analysis suggests that it was not flexible exchange rates alone that were able to rule out bank runs, but the coupling of exchange rate flexibility with a lender of last resort. This gives therefore support to the view that unofficial dollarisation (independently of the exchange rate regime) may be destabilising, as it prevents the central bank from serving as a lender of last resort, thereby wiping out the potential benefits of flexible exchange rates.

  4. See also Bussière et al. (2010) and Giannone et al. (2011) for further practical applications.

  5. It is important to stress that in this second step we are less interested in the total effect of loan dollarisation per se (already estimated in the first step) or in the total effect of each of the three channels per se. We are particularly interested in how the two play out with each other to capture the transmission of the costs of dollarisation/euroisation to the real economy. We are therefore mainly interested in their interacted effect.

  6. Arguably, the IMF has recently started to collect data on foreign-currency loans in the framework of the Financial Soundness Indicators (FSI) database; the ratios of foreign-currency loans to total loans are however part of the ‘Encouraged FSI’, not of the ‘Core FSI’, and therefore are reported only for a limited number of countries.

  7. See Rancière et al., 2010a, 2010b for details on a new index of currency mismatch measurement, which takes into account unhedged borrowers.

  8. The chart displays the actual values of pre-crisis loan dollarisation and the change in the real GDP growth rates during the crisis, together with their conditional relation which controls for the core variables included in the baseline regression.

  9. For instance, Dedola and Lombardo (2012) develop a model of financial integration and present simulation results that indicate that an unexpected increase in credit spreads in one country generates a similar increase in credit spreads in other financially integrated countries bringing about a global contraction, quite independently of the exposure to foreign assets in the balance sheet of leveraged investors. In a related vein, Devereux and Yetman (2010) develop a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors, while Mendoza and Quadrini (2010) suggest that financial globalization played an important role in the recent financial crisis, showing that financial integration leads to a sharp rise in net credit in the most financially developed country and to large asset price spillovers of country-specific shocks to bank capital.

  10. They found that ‘once we control for GDP per capita and the current account, there is no evidence that financial openness (the size of the external balance sheet) is associated with lower growth during the crisis. Indeed, this variable is significant only in column (3) and it enters with a positive sign in that case’, and that ‘higher trade openness is negatively correlated with output performance during the crisis, but the partial correlation is not statistically significant’ (Lane and Milesi-Ferretti, 2010, p. 21).

  11. Bayesian estimates indicate therefore that growth declined by almost 0.5% point more in countries where loan dollarisation was 10% points higher. The elasticity is therefore almost identical with that obtained when using OLS on the full country sample, further strengthening our central findings.

  12. The full set of results is not reported here, but is available upon request.

  13. See, for example, Krugman (1999), Chang and Velasco (2000a, 2000b), Furman and Stiglitz (1998), Allen et al. (2002), Bordo and Meissner (2005 and 2007), Céspedes et al. (2004) or Rancière et al. (2010a, 2010b), who recall the key role played by balance sheet vulnerabilities, for instance in Mexico's crisis of 1994 or in the East Asian crisis of 1997–1998.

  14. Admittedly, a more careful analysis might be warranted to understand the ‘Fischer effect’ better, such as by distinguishing between different exchange rate regimes and degrees of financial openness, in line with the standard Mundell–Fleming ‘impossible trinity’. However, this would stretch far beyond the scope of the present paper, not least due to the limited number of observations and hence of degrees of freedom available for such a particular setup. We therefore leave this extension for further research.

  15. As a further robustness check, we also centred the variables entering the interactions. Expectedly, the slope of the interaction term remains the same whether or not the main effects are centred, while only the coefficients of the main effects and the intercept change. Given that for our purpose we are only interested in the coefficient of the interaction term, centring the main effects variables has no implication for the economic interpretation discussed above.


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I am particularly indebted to Alexander Chudik for sharing his MatLab code for the BACE estimates. I am also grateful for helpful suggestions, comments and discussions to Thierry Bracke, Matthieu Bussière, Alexandra Coiculescu, Olivier Jeanne, Ricardo Lago, Hélène Rey, Livio Stracca, Marco Lo Duca and Adalbert Winkler, as well as to the members of the International Relations Committee and to participants in an ECB internal seminar, at the Infinity Conference Dublin, 11–12 June 2012, at the Dubrovnik Economic Conference, 27–29 June 2012 and at the European Economic Association Conference, 27–31 August 2012. I would also like to thank two anonymous referees for very helpful suggestions and comments. The paper has received the 2012 CFA Romania Award (macroeconomics section). The views expressed therein are those of the author and do not necessarily reflect those of the European Central Bank or the Eurosystem.

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Chiţu, L. Was Unofficial Dollarisation/Euroisation an Amplifier of the ‘Great Recession’ of 2007–2009 in Emerging Economies?. Comp Econ Stud 55, 233–265 (2013).

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  • unofficial dollarisation/euroisation
  • foreign currency lending
  • Great Recession
  • emerging economies
  • Bayesian model averaging

JEL Classifications

  • F30
  • G01
  • G21