Reflections on the perspectives of the global economy from the point of view of emerging economies
Recently a number of emerging economies, with high inflation and various kinds of imbalances have experienced what has come to be referred to as dollarization — the phenomenon of currency substitution where the dollar gradually replaces the national curre
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Abstract. Recently a number of emerging economies, with high inflation and various kinds of imbalances have experienced what has come to be referred to as dollarization ~ the phenomenon of currency substitution where the dollar gradually replaces the national currency in the performance of its fundamental functions. The phenomenon is most commonly encountered as a component of the exchange-rate-based stabilization programs implemented in a number of emerging economies in Latin America, Asia and the Middle East. The fundamental issue we want to explore is whether this process forces the monetary authorities of emerging economies to act with their hands tied, as if caught in a trap. It is argued that when the expansion of liquidity and domestic credit is determined by the quantity of foreign-exchange reserves, an independent monetary policy vanishes and national sovereignty itself is shackled. Since this scenario typically occurs in a world of increasing globalization of finance, this paper also discusses (with reference to emerging economies) the risks and implications of capital inflows for macroeconomic policy autonomy, economic instability, and vulnerability to external shocks. Key words: Systemic asymmetries stabilization ~ Speculative attacks
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dollarization
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Exchange-rate-based
JEL-cIassification: GIS, 010, 050
Paper presented at the 1998 World Conference of the International Joseph A. Schumpeter Society, Vienna, June 13-16, 1998. *The authors acknowledge research financial support provided by Brazil's National Research Council (CNPq ) and Professor Dennis C. Mueller for very helpful comments.
D. C. Mueller et al. (eds.), Capitalism and Democracy in the 21st Century © Springer-Verlag Berlin Heidelberg 2001
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M. L. F. Silva et al.
1 Introduction This paper analyzes the macroeconomic adjustment of emerging economies adopting exchange-rate-based stabilization programs (ERBSPs). It provides a brief historical description of the symmetries and asymmetries in the world-wide adjustment mechanism, and concludes that systemic asymmetries are inherent in the international monetary system. This conclusion becomes even more evident when the problems that have arisen while establishing new institutional arrangements, such as a new currency or a policy rule for monetary-base creation, are discussed. In the modern international financial system, the globalization of finance has assumed leadership. The instability of this environment, which lacks co-ordination and where emerging countries' domestic currencies are vulnerable to speculative attacks that threaten national economic autonomy, is emphasized. In fact, these economies are now highly dependent on foreign capital inflows and have become extremely vulnerable to external shocks, as under the pre-1914 gold standard. As long as capital inflows are highly volatile and dependent on economic conditions in the lending countries (push factors), they possess the permanent potential to inflict a surprise shock. In addition, the fixed-exchange-rate systems widely use
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