Exchange Rate Pass - through and Partial Dollarization : Is there a Link ?

This work examines the way dollarization affects the transmission channel of nominal exchange rate fluctuations into domestic inflation for 13 countries in Latin America between 1980-00. Contrary to “conventional wisdom” I find that dollarization across countries is not positively associated with a higher degree of exchange rate pass-through. Moreover, within a country, increases in dollarization are not associated with an increase in pass-through. The policy implications are that partially dollarized countries can still adjust their real exchange rate through nominal devaluations and that increases in dollarization do not hinder their ability to do so. Two alternative methodologies are followed: (i) long run pass-through is estimated using an Error Correction Model. When using the 20-year time period, pass-through estimates for most countries are close to one supporting a long-term stable relationship close to PPP. When breaking the time period into two, pass-through estimates are more heterogeneous. Long term pass-through coefficients and dollarization are not significantly correlated across countries. There is a consistent but also insignificant relationship between a higher speed of adjustment and the degree of dollarization. (ii) Yearly pass-through coefficients were computed and regressed in a panel framework using dollarization and inflation as explanatory variables. The crosscountry dollarization coeffiients are ambiguous supporting the long run pass-through results. Within country estimates are insignificant and split in sign. Inflation is negatively but not significantly correlated with the degree of yearly pass-through both within and across countries. 1 This is a revised version of a paper prepared for the World Bank Conference on Dollarization in Latin America held at the Universidad Torcuato di Tella in Buenos Aires, Argentina on June 5-7 2000. The author thanks participants for many useful comments. Remaining errors are mine.