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Money, Crises, and TransitionEssays in Honor of Guillermo A. Calvo$
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Carmen M. Reinhart, Carlos A. Vegh, and Andres Velasco

Print publication date: 2008

Print ISBN-13: 9780262182669

Published to MIT Press Scholarship Online: August 2013

DOI: 10.7551/mitpress/9780262182669.001.0001

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Why Should Emerging Economies Give up National Currencies? A Case for “Institutions Substitution”

Why Should Emerging Economies Give up National Currencies? A Case for “Institutions Substitution”

(p.95) 5 Why Should Emerging Economies Give up National Currencies? A Case for “Institutions Substitution”
Money, Crises, and Transition

Enrique G. Mendoza

The MIT Press

This chapter argues that abandoning national currencies to adopt a hard currency can be an effective policy for emerging economies to deal simultaneously with the lack of credibility of domestic financial policies and the imperfections of globalized capital markets, and is organized as follows. Section 5.2 documents key features of emerging-markets crises that point to the central role of noncredible policy and imperfect capital markets in causing the crises. Section 5.3 reviews some analytical results which suggest that the globalization of (imperfect) financial markets had endogenous mechanisms which increased the vulnerability of emerging economies to sudden stops. Section 5.4 summarizes an analytical framework for studying economic fluctuations in a small open economy that features a transmission mechanism linking imperfections in world capital markets with lack of credibility, or uncertain duration, of domestic economic policy. Section 5.5 draws policy conclusions.

Keywords:   national currency, hard currency, emerging economics, financial policy, fiscal policy, capital markets

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