Disadvantages Of Dollarization In Canada
Introduction
This review aims to thoroughly analyze the possibility of Canada joining a North American Monetary Union. Through globalization and trade liberalization Canada has become more and more economically dependent on the United States. Therefore a monetary union is something for the nations to consider for facilitating trade and further stabilizing inflation. Since the introduction of the euro as the national currency in Europe several other countries have been considering monetary unions. Research shows that there are several advantages to dollarization that would be both favourable for the US and Canada. As David Rosenburg stated “Canada enjoys all the inconveniences of a floating exchange rate and independent monetary policy, with precious few of the benefits.” What one must consider is if these benefits outweigh the potential loss of sovereignty. Overall, a country’s decision to officially dollarize depends on broad factors as well as narrow calculations of the quantifiable costs and benefits of seigniorage. That being said, with the increase in technology …show more content…
one now must consider e-money as a possible currency union and what effects it will have on nations.
Literature Review
Dollarization usually refers to unofficial dollarization, which is far more widespread than official dollarization.
The crucial difference between unofficial and official dollarization is whether the foreign currency is used voluntarily by residents even though it is not legal tender or whether it is officially recognized as legal tender by the government. Official or full dollarization is a complete monetary union with a foreign country from which a country imports a currency, by making the foreign currency full legal tender and reducing its own currency.1 Officially dollarized economies also have few or no restrictions on capital account transactions, and transactions for external payments are relatively free. The use of the foreign currency in their domestic economies is often necessitated by virtue of their openness and heavy reliance on trade (and factor mobility) with their larger
neighbors.
Dollarization generally occurs in undeveloped or developing countries to stabilize their economy and lower their interest rates. Generally they provide citizens with the opportunity for loans extended over longer periods of time that they would not have been able to receive with their countries previously unstable monetary system. The article analyzes the costs and benefits of full dollarization in comparison to its closest alternative, a currency board. Unlike floating rates and pegged-rate systems, a common currency eliminates uncertainties about future values of exchange rates and thereby improves the efficiency of decision-making. Monetary Unions also eliminate transaction costs, diminish risks of currency depreciation, reduce a systems needs for reserves and reduces inflation and interest rates. A major cost of this system would be the loss of seigniorage to the United States. In regards to this issue, Robert Barro believes that the US should just receive a transfer of the country’s currency in American dollars instead of receiving annual transfers based on a more complex formula. The country may also lose the “exit option” to devalue in the face of major shocks.2 Furthermore, even countries with currency boards may lose the ability to act as lenders of last resort. This method of analysis (cost-benefit) worked to capture the implications of dollarization and how its effects differ from those of a firm peg. Overall, dollarization aims to bring about more stable international capital movements on a count of the higher level of confidence it will create for foreign investors.3 This article focuses solely on developing Latino countries that will be more greatly affected by dollarization for the citizens will be receiving much better interest rates and will be able to have their loans extended over longer periods of time.
Panama is a country that has recently become dollarized. Their capital account is now completely open allowing for more foreign investment and their macroeconomic performance has been above par. They are also at a stable inflation rate of 3%.4 This dollarization has not prevented shocks to their country, but any shocks that did occur were outside the monetary system. However, unlike other countries they partake in a bi-monetary system where they can still collect seigniorage since both they still issue their own coins but also use American dollar notes.
Canada, unlike the above mentioned Latino countries is well developed. However, the traditional concerns of macroeconomic stability and policy management are still prevalent. Some observers consider the floating rate system as the cause of the slowed development of high-tech manufacturing in Canada. They believe the depreciation of the Canadian dollar to be a response to deflation in world commodity prices and that this may have shielded Canadian manufacturing in ways that undermine incentives to innovate and modernize.5 Unlike floating rates and pegged-rate systems, a common currency eliminates uncertainties about future values of exchange rates and thereby improves the efficiency of decision-making and would allow for the Canadian manufacturing industry to continue prospering.
However, Canada earns profits of around $2 billion per annum through seigniorage, and joining a North American Monetary Union would result in a partial or complete (complete being more likely) of those earnings.6 There would also be a diminution or loss of macro policy independence for Canadians. Moreover, there are several costs involved in joining a monetary union outside the loss of seigniorage. One must consider the gross stock cost of initially buying all the new money and the reduction of flexibility in monetary exchange policy. Finally, as mentioned previously, the country would also be giving up having a domestic bank as a lender of last resort.
The most prominent, and recent, monetary union is the EU. Research has demonstrated that Countries in currency unions trade amongst each other 3 times more than others. That being said, the EU has induced 6% more trade among Eurozone members.7For this to occur, the euro must make it easier, cheaper and/or safer to sell to Eurozone nations. Therefore economists believe that the euro makes the Eurozone members extraordinarily good importers, rather than extraordinarily good exporters. As stated earlier, monetary unions are somewhat of a hard peg monetary regime. To assess the efficacy of the EU and sustainability of the euro, researchers have created a model by studying the relationship between the shadow exchange rate and the output gap. This shows the capability of the member countries to remain in the hard peg regime. This is only possible as long as the difference between the costs of staying relative to the benefits does not exceed a critical value. By applying this research model, it has been determined that tensions do exist, particularly for Greece and Portugal.8 However, they are not such great tensions that could cause a breakdown of the common currency; although self-fulfilling attacks, starting in countries with weaker fundamentals, might well occur if the markets are in doubt about the political will to sustain the common currency.9
With technology becoming even more prominent in everyday life, electronic money’s potential effects on monetary unions is substantial. Although the likelihood of e-money making hard currency irrelevant is not high, it is not implausible. As the prevalence of e-money increases the monetary policy of banks is going to have to be drastically altered. However, since e-money cannot offer the anonymity and diversity of regular currency it will not override it. The dispersion of e-money increases the risk of strong currencies replacing weaker ones and creating a world hierarchy of monies. This increases the incentive to join a monetary union because the central bank that loses control over its monetary policy can either transfer its power to another organization able to control the monetary system or merge its monetary system with a better managed one.10 Moreover, on a count of e-money’s uniformity, it increases the compatibility of existing monetary systems. The higher accessibility of different networks reduces the incentive to join a full monetary union, but, a partial loss of control over the national monetary system could lead countries to enhance their collaboration beyond national borders. Therefore new forms of money (e-money) could increase the size of monetary unions thanks to information technology and economies of scale.11
Literature Critique
An overall conclusion that can be drawn from every article is that economists widely believe that monetary unions lower inflation and promote trade. Three out of the six articles evaluated monetary unions through cost-benefit analyses and came to the conclusion that the loss in seigniorage would be compensated for through the improvement of trade and the further stabilization of the economy. However the lack in consistent research makes the validity of these statements less credible. The dates of publication vary from 2000 to 2012. Moreover, a majority of the articles that were used cited sources from the 1990’s making the information quite outdated. More recent sources have up-to-date findings and other developments that take precedence in the accumulation of information to support any point being made in any academic article, therefore having more recent articles would have thoroughly benefited my research.
The article, "The Sustainability of Monetary Unions - Can the Euro Survive?" was crucial to my research for it analyzed one of the largest and most influential monetary unions. The article pointed out how the monetary union affected the nations involved and areas for improvement. This information was necessary since the European countries in the EU are the only real-life example Canadians can base their decision on. However, the article did contain some bias. The work was written by two Italian men studying at the University of Rome and thus a majority of the samples they used were Italian based. This bias means that it is possible that the author may not have paid attention to all the facts that were available to them just so that they can support their perspective. Or it is possible that the authors selected only facts that supported monetary unions. Either way, a truthful and factual conclusion cannot be drawn when bias is present in writing for the audience is only receiving a skewed version of the facts. The EU may have directly contributed to improved conditions in Italy and therefore the potential benefits of monetary unions are clear, but it does not give an exact representation of how monetary unions affect their members. There was absolutely no mention of the Greece crisis and how this affected the EU. Americans are just recovering from a recession, as is Canada and information like such would be extremely beneficial when considering the creation of the amero.
The other article that was essential to my research was "The Pros and Cons of North American Monetary Integration." Almost every article used an underdeveloped country as their example of how monetary unions are beneficial and have the potential to be successful. Logically this makes sense: attaching ones volatile currency to a stable one, however Canada and the United States are fully developed countries. Canada is not in a risky financial situation nor are they on the brink of an economic downfall. This is where Sven Arndt analysis of a North American Monetary Union is most prominent. He determines that through deduced exchange rate uncertainty, and price transparency Canada would be on the winning side of the Union. However, in a sense they would be giving up their sovereignty. They would no longer be in charge of their own monetary policy and would be in complete control of the US.
The lack in sufficient research done specifically for the United States and Canada make it impossible to make a well informed decision on whether it would benefit or hurt the Canadians. There was not one sample that went to the Canadians and asked them if they would support a monetary union. Moreover, no articles discussed how the differentiating health care systems would come into play. When the EU was established they ensured certain things beforehand. They made certain that every one of the joining nations had healthcare available to its citizens and that interest and inflation rates were stable and low. This article did not mention any specifics on how the North American Nations should go about this deal taking into consideration each countries specific needs. However only one of the six articles (Official Dollarization: Current Experiences and Issues) did address this topic.
Arndt also pointed out several times how it would be a major loss in sovereignty if Canada were to adopt the American dollar. Moreover, he argues that we will become overly dependent on the US thus leading to the mergence of our economies. That being said, many economists predicted this when the North American Free Trade Agreement was implemented but Canadians are still a sovereign nation and although the US is one of our major trade partners our reliance on them for business has not impacted us negatively. Therefore the arguments presented in this section of Arndt’s article are neither valid nor relevant.
In conclusion, in a globalizing world, with large and rapid capital flows, the scope for truly independent monetary policy is limited. At one end of the spectrum, countries operating currency boards have already sacrificed flexibility in monetary policy in exchange for the long term benefits of low inflation and stable currency. Thus it is possible that as globalization continues, the politics of monetary policy may shift from national sovereignty to an emphasis on regional integration. As Hisham Foad pointed out, the floating exchange rate’s days are limited. Floating rates make real exchange rates more unstable. They also do not appear to offer effective buffers against external shocks, and can result in prolonged currency misalignments, as the current period of pronounced weakness relative to the US dollar demonstrates. However, in order to make any valid conclusions it is necessary economists conduct more research on the trends in monetary policy.
Works Cited
Arndt, Sven W. "The Pros and Cons of North American Monetary Integration." University of Calgary
Press. Robert Day School of Economics and Finance, 2003. Web. 27 Mar. 2014.
Bandiera, Luca. "Monetary Policy, Monetary Areas, and Financial Development with Electronic
Money." Social Science Research Network. IMF Working Paper No. 04/122, July 2004. Web. 1 Mar. 2014.
Bogetic, Zeljko. "Official Dollarization: Current Experiences and Issues." Social Science Research Centre.
Cato Journal, 1 Oct. 2000. Web. 13 Mar. 2014.
Canofari, Paolo, and Giancarlo Marini. "The Sustainability of Monetary Unions - Can the Euro
Survive?" Social Science Research Network. University of Rome II - Faculty of Economics, 4 Mar. 2012. Web. 1 Mar. 2014.
Foad, Hisham S. "Currency Unions, Options, and Foreign Direct Investment." Social Science Research
Centre. San Diego State University - Department of Economics, 10 Feb. 2005. Web. 13 Mar. 2014.
Rosenburg, David. "Should Canada and America Share the Same Dollar?" The Globe and Mail. N.p., 23
Oct. 2009. Web. 4 Mar. 2014.
This review aims to thoroughly analyze the possibility of Canada joining a North American Monetary Union. Through globalization and trade liberalization Canada has become more and more economically dependent on the United States. Therefore a monetary union is something for the nations to consider for facilitating trade and further stabilizing inflation. Since the introduction of the euro as the national currency in Europe several other countries have been considering monetary unions. Research shows that there are several advantages to dollarization that would be both favourable for the US and Canada. As David Rosenburg stated “Canada enjoys all the inconveniences of a floating exchange rate and independent monetary policy, with precious few of the benefits.” What one must consider is if these benefits outweigh the potential loss of sovereignty. Overall, a country’s decision to officially dollarize depends on broad factors as well as narrow calculations of the quantifiable costs and benefits of seigniorage. That being said, with the increase in technology …show more content…
one now must consider e-money as a possible currency union and what effects it will have on nations.
Literature Review
Dollarization usually refers to unofficial dollarization, which is far more widespread than official dollarization.
The crucial difference between unofficial and official dollarization is whether the foreign currency is used voluntarily by residents even though it is not legal tender or whether it is officially recognized as legal tender by the government. Official or full dollarization is a complete monetary union with a foreign country from which a country imports a currency, by making the foreign currency full legal tender and reducing its own currency.1 Officially dollarized economies also have few or no restrictions on capital account transactions, and transactions for external payments are relatively free. The use of the foreign currency in their domestic economies is often necessitated by virtue of their openness and heavy reliance on trade (and factor mobility) with their larger
neighbors.
Dollarization generally occurs in undeveloped or developing countries to stabilize their economy and lower their interest rates. Generally they provide citizens with the opportunity for loans extended over longer periods of time that they would not have been able to receive with their countries previously unstable monetary system. The article analyzes the costs and benefits of full dollarization in comparison to its closest alternative, a currency board. Unlike floating rates and pegged-rate systems, a common currency eliminates uncertainties about future values of exchange rates and thereby improves the efficiency of decision-making. Monetary Unions also eliminate transaction costs, diminish risks of currency depreciation, reduce a systems needs for reserves and reduces inflation and interest rates. A major cost of this system would be the loss of seigniorage to the United States. In regards to this issue, Robert Barro believes that the US should just receive a transfer of the country’s currency in American dollars instead of receiving annual transfers based on a more complex formula. The country may also lose the “exit option” to devalue in the face of major shocks.2 Furthermore, even countries with currency boards may lose the ability to act as lenders of last resort. This method of analysis (cost-benefit) worked to capture the implications of dollarization and how its effects differ from those of a firm peg. Overall, dollarization aims to bring about more stable international capital movements on a count of the higher level of confidence it will create for foreign investors.3 This article focuses solely on developing Latino countries that will be more greatly affected by dollarization for the citizens will be receiving much better interest rates and will be able to have their loans extended over longer periods of time.
Panama is a country that has recently become dollarized. Their capital account is now completely open allowing for more foreign investment and their macroeconomic performance has been above par. They are also at a stable inflation rate of 3%.4 This dollarization has not prevented shocks to their country, but any shocks that did occur were outside the monetary system. However, unlike other countries they partake in a bi-monetary system where they can still collect seigniorage since both they still issue their own coins but also use American dollar notes.
Canada, unlike the above mentioned Latino countries is well developed. However, the traditional concerns of macroeconomic stability and policy management are still prevalent. Some observers consider the floating rate system as the cause of the slowed development of high-tech manufacturing in Canada. They believe the depreciation of the Canadian dollar to be a response to deflation in world commodity prices and that this may have shielded Canadian manufacturing in ways that undermine incentives to innovate and modernize.5 Unlike floating rates and pegged-rate systems, a common currency eliminates uncertainties about future values of exchange rates and thereby improves the efficiency of decision-making and would allow for the Canadian manufacturing industry to continue prospering.
However, Canada earns profits of around $2 billion per annum through seigniorage, and joining a North American Monetary Union would result in a partial or complete (complete being more likely) of those earnings.6 There would also be a diminution or loss of macro policy independence for Canadians. Moreover, there are several costs involved in joining a monetary union outside the loss of seigniorage. One must consider the gross stock cost of initially buying all the new money and the reduction of flexibility in monetary exchange policy. Finally, as mentioned previously, the country would also be giving up having a domestic bank as a lender of last resort.
The most prominent, and recent, monetary union is the EU. Research has demonstrated that Countries in currency unions trade amongst each other 3 times more than others. That being said, the EU has induced 6% more trade among Eurozone members.7For this to occur, the euro must make it easier, cheaper and/or safer to sell to Eurozone nations. Therefore economists believe that the euro makes the Eurozone members extraordinarily good importers, rather than extraordinarily good exporters. As stated earlier, monetary unions are somewhat of a hard peg monetary regime. To assess the efficacy of the EU and sustainability of the euro, researchers have created a model by studying the relationship between the shadow exchange rate and the output gap. This shows the capability of the member countries to remain in the hard peg regime. This is only possible as long as the difference between the costs of staying relative to the benefits does not exceed a critical value. By applying this research model, it has been determined that tensions do exist, particularly for Greece and Portugal.8 However, they are not such great tensions that could cause a breakdown of the common currency; although self-fulfilling attacks, starting in countries with weaker fundamentals, might well occur if the markets are in doubt about the political will to sustain the common currency.9
With technology becoming even more prominent in everyday life, electronic money’s potential effects on monetary unions is substantial. Although the likelihood of e-money making hard currency irrelevant is not high, it is not implausible. As the prevalence of e-money increases the monetary policy of banks is going to have to be drastically altered. However, since e-money cannot offer the anonymity and diversity of regular currency it will not override it. The dispersion of e-money increases the risk of strong currencies replacing weaker ones and creating a world hierarchy of monies. This increases the incentive to join a monetary union because the central bank that loses control over its monetary policy can either transfer its power to another organization able to control the monetary system or merge its monetary system with a better managed one.10 Moreover, on a count of e-money’s uniformity, it increases the compatibility of existing monetary systems. The higher accessibility of different networks reduces the incentive to join a full monetary union, but, a partial loss of control over the national monetary system could lead countries to enhance their collaboration beyond national borders. Therefore new forms of money (e-money) could increase the size of monetary unions thanks to information technology and economies of scale.11
Literature Critique
An overall conclusion that can be drawn from every article is that economists widely believe that monetary unions lower inflation and promote trade. Three out of the six articles evaluated monetary unions through cost-benefit analyses and came to the conclusion that the loss in seigniorage would be compensated for through the improvement of trade and the further stabilization of the economy. However the lack in consistent research makes the validity of these statements less credible. The dates of publication vary from 2000 to 2012. Moreover, a majority of the articles that were used cited sources from the 1990’s making the information quite outdated. More recent sources have up-to-date findings and other developments that take precedence in the accumulation of information to support any point being made in any academic article, therefore having more recent articles would have thoroughly benefited my research.
The article, "The Sustainability of Monetary Unions - Can the Euro Survive?" was crucial to my research for it analyzed one of the largest and most influential monetary unions. The article pointed out how the monetary union affected the nations involved and areas for improvement. This information was necessary since the European countries in the EU are the only real-life example Canadians can base their decision on. However, the article did contain some bias. The work was written by two Italian men studying at the University of Rome and thus a majority of the samples they used were Italian based. This bias means that it is possible that the author may not have paid attention to all the facts that were available to them just so that they can support their perspective. Or it is possible that the authors selected only facts that supported monetary unions. Either way, a truthful and factual conclusion cannot be drawn when bias is present in writing for the audience is only receiving a skewed version of the facts. The EU may have directly contributed to improved conditions in Italy and therefore the potential benefits of monetary unions are clear, but it does not give an exact representation of how monetary unions affect their members. There was absolutely no mention of the Greece crisis and how this affected the EU. Americans are just recovering from a recession, as is Canada and information like such would be extremely beneficial when considering the creation of the amero.
The other article that was essential to my research was "The Pros and Cons of North American Monetary Integration." Almost every article used an underdeveloped country as their example of how monetary unions are beneficial and have the potential to be successful. Logically this makes sense: attaching ones volatile currency to a stable one, however Canada and the United States are fully developed countries. Canada is not in a risky financial situation nor are they on the brink of an economic downfall. This is where Sven Arndt analysis of a North American Monetary Union is most prominent. He determines that through deduced exchange rate uncertainty, and price transparency Canada would be on the winning side of the Union. However, in a sense they would be giving up their sovereignty. They would no longer be in charge of their own monetary policy and would be in complete control of the US.
The lack in sufficient research done specifically for the United States and Canada make it impossible to make a well informed decision on whether it would benefit or hurt the Canadians. There was not one sample that went to the Canadians and asked them if they would support a monetary union. Moreover, no articles discussed how the differentiating health care systems would come into play. When the EU was established they ensured certain things beforehand. They made certain that every one of the joining nations had healthcare available to its citizens and that interest and inflation rates were stable and low. This article did not mention any specifics on how the North American Nations should go about this deal taking into consideration each countries specific needs. However only one of the six articles (Official Dollarization: Current Experiences and Issues) did address this topic.
Arndt also pointed out several times how it would be a major loss in sovereignty if Canada were to adopt the American dollar. Moreover, he argues that we will become overly dependent on the US thus leading to the mergence of our economies. That being said, many economists predicted this when the North American Free Trade Agreement was implemented but Canadians are still a sovereign nation and although the US is one of our major trade partners our reliance on them for business has not impacted us negatively. Therefore the arguments presented in this section of Arndt’s article are neither valid nor relevant.
In conclusion, in a globalizing world, with large and rapid capital flows, the scope for truly independent monetary policy is limited. At one end of the spectrum, countries operating currency boards have already sacrificed flexibility in monetary policy in exchange for the long term benefits of low inflation and stable currency. Thus it is possible that as globalization continues, the politics of monetary policy may shift from national sovereignty to an emphasis on regional integration. As Hisham Foad pointed out, the floating exchange rate’s days are limited. Floating rates make real exchange rates more unstable. They also do not appear to offer effective buffers against external shocks, and can result in prolonged currency misalignments, as the current period of pronounced weakness relative to the US dollar demonstrates. However, in order to make any valid conclusions it is necessary economists conduct more research on the trends in monetary policy.
Works Cited
Arndt, Sven W. "The Pros and Cons of North American Monetary Integration." University of Calgary
Press. Robert Day School of Economics and Finance, 2003. Web. 27 Mar. 2014.
Bandiera, Luca. "Monetary Policy, Monetary Areas, and Financial Development with Electronic
Money." Social Science Research Network. IMF Working Paper No. 04/122, July 2004. Web. 1 Mar. 2014.
Bogetic, Zeljko. "Official Dollarization: Current Experiences and Issues." Social Science Research Centre.
Cato Journal, 1 Oct. 2000. Web. 13 Mar. 2014.
Canofari, Paolo, and Giancarlo Marini. "The Sustainability of Monetary Unions - Can the Euro
Survive?" Social Science Research Network. University of Rome II - Faculty of Economics, 4 Mar. 2012. Web. 1 Mar. 2014.
Foad, Hisham S. "Currency Unions, Options, and Foreign Direct Investment." Social Science Research
Centre. San Diego State University - Department of Economics, 10 Feb. 2005. Web. 13 Mar. 2014.
Rosenburg, David. "Should Canada and America Share the Same Dollar?" The Globe and Mail. N.p., 23
Oct. 2009. Web. 4 Mar. 2014.