Wurtz 2
Abstract: Dollarization is an increasingly important subject in the IPE literature. While the
process of dollarization is driven by economic concerns, the way in which it occurs is contingent
upon a political decision by government officials to allow citizens to possess foreign currency
deposits. Allowing citizens to maintain FC deposits is a potentially puzzling choice for
developing countries, as it sacrifices some, but not all, sovereignty over monetary affairs. I
argue that the decision to allow FC deposits is done as a commitment device, binding
governments to orthodox macroeconomic policies. Thus, I expect a change in regulation to be
most likely soon after introduction of macroeconomic policy reform. I use event history
analysis on a sample of 95 countries to test my hypotheses and present preliminary results of
weak support for my hypothesis. Keywords: dollarization, exchange rates, capital controls,
financial liberalization
One implication of a rise in capital mobility is an increase in competition between
currencies; once individuals are allowed access to alternatives to their national currency there is
the danger that they will find a foreign currency more desirable, abandon their loyalty to the
national currency and exit to a more appealing option. In many emerging markets, this is exactly
what is occurring. Indeed, in 1996, researchers at the U.S. Federal Reserve estimated that
between 30 to 70 percent of the total supply of U.S. dollars circulated outside the borders of the
United States, depending on the estimation technique used. (Porter and Judson 1996) In many
developing and transitional economies these overseas dollars compete with the domestic
currency for some or all of the three uses of money (medium of exchange, store of value, and
unit of account). This phenomenon has lead some authors (Hausmann 1999, Cohen 1998) to
believe that such competition will lead governments to abandon their domestic currencies.
However, viewing exchange rate regime choices as driven purely by competitive pressures is
overly deterministic and underspecifies (or ignores) the political dynamics created by currency
competition.
In this paper, I analyze the decision by governments to allow domestic residents to
maintain bank accounts denominated in foreign currencies using duration analysis. While not a
direct decision on the exchange rate regime, it is a good test of an implication of the evolutionary
Convention