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Liquidity Shocks and the Dollarization of a Banking System
Carlos Gustavo Machicado
September 2006
This
paper shows how uncertainty about liquidity demand can lead to a
high degree of dollarization in the banking system. I study a
model where the demand for currency in each period is random,
and where it is easier for banks to borrow in local currency in
times of crisis than in dollars. Banks choose a portfolio
composed of local currency, dollars, and real loans. Compared to
the anticipated transactions demand for each currency, I show
that the bank will hold a relatively large amount of dollars and
a relatively small amount of local currency. I also show the
existence of a dollarization multiplier : as the anticipated
transactions demand for dollars increases, the dollarization of
the banking sector increases more than proportionately.
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