In today’s Gleaner, economist Dr Andre Haughton explored the issue of dollarisation as a possible way to help stabilise Jamaica’s macro economy and also solve the problem of our steadily declining local currency. Do you know what that is?
In simple terms, dollarisation is the situation in which a country replaces its domestic currency with that of another country. This foreign currency becomes the legal tender used to conduct day-to-day transactions and as a store of value.
There are three types of dollarisation:
- Full or official dollarisation entails a direct substitution as the foreign currency completely replaces the domestic currency as legal tender. Countries that have been fully dollarised, using the US dollar, include the British Virgin Islands, El Salvador, Panama and the Turks and Caicos Islands.
- Semi-official dollarisation occurs when the domestic currency is used alongside the foreign dollar as legal tender. Countries that have done this include The Bahamas, Barbados, Costa Rica and Uruguay.
- Unofficial dollarisation or asset substitution occurs when residents of a country hold a significant portion of their financial instruments (such as bank deposits, stocks and bonds) in foreign currency instead of local currency, as in the case of Jamaica. According to this IMF article, Full Dollarization The Pros and Cons, “such informal [dollarization] is a response to economic instability and high inflation, and the desire of residents to diversify and protect their assets from the risks of devaluation of their own currencies.”
What are the benefits of full or official dollarisation?
According to Dr Haughton:
- Official dollarisation can improve Jamaica’s trade and investment. If Jamaica decides to use the US dollar as legal tender, this would remove all the foreign currency transaction cost between Jamaica and the US as well as between Jamaican and any other country that uses the US dollar.
- Jamaica might increase investors’ confidence in the economy, in so doing attract more investment to the country as investors face less exchange-rate risk. This increase in investment could boost production and stimulate economic growth.
- Dollarisation can also improve availability of foreign currency (liquidity) and reduces the possibility of a currency crisis arising from the financial market channel.
What are the drawbacks?
Dr Haughton continued:
- Jamaica would lose control of its monetary policy and the ability to use exchange rate as a tool to impact the economy. For example, Jamaica could not depreciate the value of its currency in an attempt to increase international trade under any circumstance.
- The government would lose the ability to print money to pay domestic debt or to finance domestic public expenditure. Neither could they print money to lend to commercial banks in cases of emergency.
- If the economy is financially dollarised, commercial banks might encounter mismatch currency risk and default risk.
Read Dr Haughton’s full article Should Jamaica Dollarise and the IMF article here for more information and history of this practice.