Financial crises, dollarization, and lending of last resort in open economies

Luigi Bocola, Guido Lorenzoni

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

Foreign currency debt is considered a source of financial instability in emerging markets. We propose a theory in which liability dollarization arises from an insurance motive of domestic savers. Since financial crises are associated to depreciations, savers ask for a risk premium when saving in local currency. This force makes domestic currency debt expensive, and incentivizes borrowers to issue foreign currency debt. Providing ex post support to borrowers can alleviate the effect of the crisis on savers’ income, lowering their demand for insurance, and, surprisingly, it can reduce ex ante incentives to borrow in foreign currency.

Original languageEnglish (US)
Pages (from-to)2524-2557
Number of pages34
JournalAmerican Economic Review
Volume110
Issue number8
DOIs
StatePublished - Aug 2020

ASJC Scopus subject areas

  • Economics and Econometrics

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