Chapter

Liquidity Insurance in a Financially Dollarized Economy

Eduardo Levy Yeyati

in Financial Markets Volatility and Performance in Emerging Markets

Published by University of Chicago Press

Published in print March 2008 | ISBN: 9780226184951
Published online February 2013 | e-ISBN: 9780226185040 | DOI: http://dx.doi.org/10.7208/chicago/9780226185040.003.0007
Liquidity Insurance in a Financially Dollarized Economy

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This chapter which revisits the evidence on the incidence of financial dollarization (FD) on the propensity to suffer bank runs and documents the positive link between FD and accumulation of reserves, shows that FD has been a motive for this form of self-insurance—in addition to the capital account reversal often noted in the literature. It analyzes and compares available insurance options, and explores the incentive problems associated with centralized holdings of reserves at the central bank, when the latter, among other uses, are expected to provide dollar liquidity insurance to individual banks. The chapter argues in favor of a combined scheme of decentralized liquid asset requirement to limit moral hazard, and an ex ante suspension-of-convertibility clause or “circuit breaker” that mitigates the costs of belated action while limiting the need for costly self-insurance.

Keywords: financial dollarization; bank runs; reserves; self-insurance; capital account reversal; dollar liquidity; liquid asset requirement; circuit breaker

Chapter.  12198 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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