3What Causes Dollarization?


As mentioned in Chapter 1, there are various reasons as to why dollarization takes hold in an economy. Our aim in this chapter is to highlight some of the main causes of partial dollarization across different regions and specific countries around the world.

We start the chapter by introducing the theoretical link between inflation and dollarization while highlighting the importance of exchange rate movements as a determinant of dollarization and explaining the transmission mechanism through which exchange rates are passed onto inflation. In line with the inflation and dollarization argument, we then analyze currency substitution theory, using empirical evidence drawn from literature and from the behavior ...

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