Dollarization and Macroeconomic Stability in Latin America.

Abstract

This paper examines if dollarization has had a positive impact on the macroeconomic stability of Latin American countries. Dollarization refers to either the official or unofficial replacement of local currencies with the U.S. dollar. Currently four Latin American countries are officially dollarized and the rest experience varying levels of unofficial dollarization. Data from the World Bank World Development Indicators for 21 Latin American countries from 1960 to 2003 are analyzed. To test the claim that dollarization improves macroeconomic stability, we construct a new measure of dollarization. Statistical analysis shows that increased dollarization is positively associated with economic growth. Dollarization has a strong impact on inflation. Data suggests that dollarization significantly reduces inflation. This research has serious implications for the Free Trade of the Americas Association (FTAA) and suggests economic and development gains would come with a single currency union for the Western Hemisphere.