3. Floating Exchange Rate Regime in Highly Dollarized Countries: Mission Impossible

Abstract

This study is the first of its kind to investigate and provide scientific evidence on the impossibility of floating the exchange rate in highly Dollarized and very highly Dollarized countries. The study examines the phenomenon of dollarization, particularly focusing on the risks and benefits associated with different exchange rate regimes in highly dollarized economies. Dollarization, prevalent in countries facing political instability and weak governance, is a major source of macroeconomic volatility, fragility, and constraints on monetary policy. Through an analysis of historical and contemporary case studies, the paper investigates the effects of full dollarization, currency boards, and flexible exchange rate regimes on financial stability, inflation control, and sovereign debt. The research highlights the limitations of floating exchange rates in dollarized economies, where exchange rate volatility exacerbates external shocks and undermines public confidence. Moreover, the study emphasizes the trade-offs between monetary autonomy and financial stability, proposing that highly dollarized countries may benefit more from hard peg arrangements. This approach reduces risks of currency crises but limits the flexibility of domestic monetary policy. The findings provide insights for policymakers in emerging and developing economies who are navigating the challenges of de-dollarization and exchange rate management.

Keywords: Dollarization, Exchange Rate Regimes, Financial Stability, Currency Crisis, Currency Board, De-dollarization.