Policies for Transactional De-Dollarization: Theory and Experiment

Conditionally Accepted at JEBO 2021

Partial currency substitution typically occurs in small open economies amid economic crises. The local currency loses some of its essential functions, and a foreign currency, usually the US Dollar, becomes widely adopted. Interestingly, the coexistence of the two currencies often persists even after macroeconomic stability returns. This persistence imposes challenges to the conduct of monetary policy. Central banks have responded by applying de-dollarization policies. We extend the model in Matsuyama et al. (1993) and implement an experiment to study the effectiveness of two de-dollarization interventions: (1) taxes on transactions in foreign currency among domestic agents and (2) a reduction in the storage costs of local currency. We contribute to the theoretical literature by characterizing a new circulation regime for small open economies where agents use the foreign currency (FC) solely for international trade purposes and settle domestic transactions exclusively in local currency. Our experimental evidence suggests that taxes (treatment 1) and storage cost (treatment 2) can foster de-dollarization as they reduce foreign currency acceptance and reinforce the use of local currency. However, we find that the impact of a reduction in the storage costs of local currency is more significant and more robust. They lower the acceptance rate of FC by more than 20% and increased the acceptance of LC by more than 30%. The tax policy only reduced foreign currency acceptance by a smaller amount and only for encounters with foreign agents. Conditionally Accepted at Information Systems Research

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Recommended citation: Arrieta, J., Florián, D., López Vargas, K, and Morales, V. (2021). "Policies for Transactional De-Dollarization: A Laboratory Study." Working Paper.