The Political Economy of International Finance in an Age of Inequality
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The Political Economy of International Finance in an Age of Inequality

Soft Currencies, Hard Landings

Edited by Gerald A. Epstein

The essays in this book describe and analyze the current contours of the international financial system, covering both developed and developing countries, and focusing on the ways in which the current international financial system structures, and is affected by, profound inequalities in the international system. This keen analysis of key topics in international finance takes a heterodox perspective, with focus on the role of inequalities in power in shaping the structure and outcomes in the international sphere.
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Chapter 8: Monetary policy under financial dollarization: The case of the Eurasian Economic Union

Zhandos Ybrayev

Abstract

Despite the general improvement in controlling price levels over the last two decades, a substantial number of the population in emerging market economies still save and borrow in foreign-denominated currencies. There are reasons to believe, however, that a high degree of financial dollarization presents obstacles in the transmission mechanisms of monetary policy and to the overall functioning of the financial sector. In the case of a typical developing economy – where external debts are denominated in foreign currency and domestic firms rely heavily on receipts in national currency – these difficulties are magnified. Financial dollarization in developing economies potentially leads to higher vulnerability of the domestic banking sector because of currency mismatch issues and large fluctuations in exchange rates, prompting the need for inflation-targeting monetary policy. This chapter investigates features of a high level of financial dollarization and the challenges it presents to inflation-targeting monetary policy in the Eurasian Economic Union. Based on a regression analysis, the chapter finds evidence that that the high level of financial dollarization in these countries tends to increase upward inflationary pressures at least in the short run, change the composition of total savings away from domestic currencies toward foreign ones, which potentially increases financial fragility in the banking sector. Thus, persistent high levels of financial dollarization imply that monetary policy is significantly limited through a greater exposure of banking sector to currency mismatches issues, which further increases demand for foreign assets.

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