Wurtz 3
argument in that the forces that have supposedly made national currencies an endangered species
should parallel those driving the decision to allow FC deposits. It is puzzling, then, that the
number of countries that have officially dollarized is small, while the number allowing FC
deposits is much larger. I argue that this discrepancy makes sense once one takes a broader view
of the process of dollarization. Allowing citizens to maintain such bank accounts allows a
government to send a costly signal to its domestic audience that it is committed to pursuing
stable macroeconomic policies. De facto dollarization erodes monetary sovereignty by
compromising the monopoly on monetary issuance, constrains politicians’ ability to pursue an
independent monetary policy, and reduces the amount of seignorage revenue governments can
earn. By explicitly giving citizens the capability to inflict this harm, should the government fail
to live up to expectations, politicians are signaling their type. Finally, allowing an exit option
could reduce the need for citizens to utilize their voice option on exchange rate policy, which
would be a further explanation for the gap in numbers between de facto and de jure dollarized
economies.
The preliminary results are mixed. While the presence of an attempt at economic reform
is in the expected direction of being positively related to the decision to allow FC deposits, the
relationship is only mildly significant and does not reach traditional levels of significance.
However, these results are very preliminary and I believe worth investigating further.
The Phenomenon
While often associated with Latin America, de facto dollarization is not limited to the
region, however, as it occurs in many developing and transitional economies. It is often
extensive and varies both cross-sectionally and across time. In 2001, the mean level of foreign
Convention