Abstract
Euroisation/dollarisation – the replacement of the domestic currency by a foreign currency, mostly the US dollar or the euro – has regained significant popularity in recent years, as it is generally regarded as a viable ‘corner solution’ for exchange rate regimes. Part of its attractiveness is related to its alleged virtues of fostering greater economic integration with the anchor country, thereby endogenously supporting its sustainability. Support for this argument is often based on the positive experience of existing euroisation/dollarisation regimes and their close links with the respective anchor countries. This paper takes a closer look at the cases of sustained euroisation/dollarisation and highlights three special features that characterise many of these countries: substantial fiscal transfers from the anchor country, financial integration through offshore finance and real integration via the development of tourism activities. These special features might have been crucial in sustaining euroisation/dollarisation. Hence, some caution may be warranted when using this experience as evidence in favour of endogenous sustainability of this exchange rate regime.
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Notes
This paper focuses only on the official adoption of a foreign currency as a country's own and does not consider the unofficial or parallel use of a foreign currency. Moreover, while acknowledging significant differences between multilateral currency unions and unilateral euroisation/dollarisation (Angeloni, 2002), we use the terms currency union and euroisation/dollarisation as synonyms. This is in line with the literature inspired by Rose and co-authors (eg Glick and Rose, 2001), who define a currency union as a situation in which money is interchangeable between two countries at par for an extended period of time. This definition encompasses both euroised/dollarised countries and members of multilateral currency unions.
See, for example, Berg et al. (2002), Gligorov (2001), Bratkowski and Rostowski (2001), Begg et al. (2001).
Bayoumi and Mauro (2001) argue that in addition to real and financial integration countries forming a common currency area have to have a political willingness to accept a certain loss of sovereignty to achieve greater economic integration.
However, as Glick and Rose (2001) emphasise, the trade effect may take some time. Hence, the immediate effects of adopting a foreign currency on trade between the euroised/dollarised country and the anchor country could be rather small.
European Monetary Union countries were excluded, as the history of EMU is too short to draw empirical conclusions.
Moreover, Persson (2001) and Nitsch (2002) found that the trade integration effects might be considerably smaller than suggested by Rose, whereas Klein (2002) presents evidence for strictly dollarised countries, that is, countries that adopted the US dollar, showing that the Rose result is not robust if only bilateral United States trade is considered.
Kose and Prasad (2002) define a ‘small state’ as a souvereign country with fewer than one and a half million people. Easterly and Kraay (2000) define a ‘microstate’ as a country having an average population over the period 1960–1995 of less than one million.
As the common currencies of the CFA franc zone and the ECCA have been closely linked to the franc/euro and the US dollar, these currency unions essentially act as fixed exchange rate regimes (Bayoumi and Mauro, 2001). Hence, an analysis of the sustainability of these currency unions should focus on the relation between members of the respective currency unions and the respective anchor countries (France and the United States).
The list of ODA-dependent countries is based on OECD (2002) and CIA World Factbook data. From the OECD, we take countries to be ODA-dependent if net receipts of ODA to Gross National Income in the last year for which data are available exceed 5% and simultaneously at least 20% of ODA received incomes from a single donor (32 countries, of which 13 are CU members). In order to capture countries for which no breakdown by donor is available, it also considered as aid dependent those countries for which ODA to GNI exceeds 20% regardless of the share of the largest donor (10 countries, of which four are CU members).
The data from the OECD is complemented with those countries that the CIA World Factbook refer to as receiving “substantial transfers” or being “highly dependent on subsidies”. This cross-referencing is necessary both because the OECD coverage is limited to 175 countries and also to capture more subtle cases through which countries may receive official transfers. More detailed information is available from the authors on request.
That some euroised/dollarised countries have been highly dependent on official transfers from the anchor country or the international community has previously been noted by Edwards (2001) and Nitsch (2002).
12 Countries are considered to be OFCs if they appear classified as tax havens by the OECD (2000) or were reported as such by the Financial Stability Forum (FSF, 2000). The list includes the six ‘advance commitment jurisdictions’ that were not named in the OECD report because they had made public a commitment to eliminate their harmful tax practices prior to the publication of the OECD report.
This figure excludes USD 2.7 trillion that are held at International Financial Centres in New York, London and Tokyo (IMF, 2000a).
As in the case of fiscal transfers, the empirical evidence on whether financial integration amplifies or smoothes shocks is mixed, however. Whereas deeper financial integration has been associated with lower output volatility in small developing countries (IMF, 2002), it has not reduced their aggregate consumption volatility (Kose and Prasad, 2002). Moreover, the experience of countries in the Western hemisphere suggests that financial integration has not led to a cushioning of temporary asymmetric shocks.
This does not imply that offshore centres were founded with the view to support the exchange rate regime. Rather, small countries engaged in offshore activities with the primary reason of generating income (IMF, 2000; Levin, 2002; Suss et al., 2002), as part of a development strategy. However, income generated by offshore activities represents – ceteris paribus – a balance of payments surplus as offshore services are provided to non-residents only. Accordingly, for small countries offshore activities help mitigating the balance of payments constraint of euroisation/dollarisation by providing a rather stable flow of hard currency earnings.
Latest available data on overnight visitors for all countries reported in the World Tourism Organisation (WTO) Compendium of Tourism Statistics (2002 edition). Calculations are available from the authors on request.
Detailed evidence is available from the authors on request.
According to Edwards and Magendzo (2002), it is the performance of the highly touristic ECCA countries which lead to the econometric result that, with other things given, CU members grow at a faster rate than countries with a domestic currency.
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1This is a revised version of the paper presented at the 8th Dubrovnik Conference in June 2002. The authors are grateful to Gunnar Jonsson, Arnaud Mehl, Jeff Miller, Paul Wachtel and an anonymous referee for helpful comments and to Oscar Calvo-Gonzales for excellent research assistance. Views expressed are those of the authors and not necessarily those of the European Central Bank.
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Mazzaferro, F., Thimann, C. & Winkler, A. On the Sustainability of Euroisation/Dollarisation Regimes: How Important are Fiscal Transfers, Offshore Finance and Tourism Receipts?. Comp Econ Stud 45, 421–436 (2003). https://doi.org/10.1057/palgrave.ces.8100015
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DOI: https://doi.org/10.1057/palgrave.ces.8100015
Keywords
- euroisation/dollarisation
- international finance
- international monetary arrangements
- exchange rate regimes