Latin America has enjoyed strong growth during the last decade, with annual growth averaging 4½ percent compared with 2¾ in the 1980s and 1990s. What is behind this remarkable economic performance and will this growth be sustainable in the years ahead? Our recent study (see also our working paper) looks at the supply-side drivers of growth for a large […]
Dollarization has been a feature of banking systems of many Latin American countries. Financial dollarization—the process in which a large share of residents’ assets and liabilities are denominated in U.S. dollars—has been a distinguishing feature of the banking sector of many countries in Latin America, making it one of the most dollarized regions in the world. Although it was largely a consequence of past episodes of severe economic crises and high inflation, financial dollarization has remained stubbornly high even after a prolonged period of economic stability and low inflation.
Reviewing the literature on Dutch disease, we document that shocks that trigger foreign exchange inflows (such as natural resource booms, surges in foreign aid, remittances, or capital inflows) appreciate the real exchange rate, generate factor reallocation, and reduce manufacturing output and net exports. We also observe that real exchange rate misalignment due to overvaluation, and higher volatility of the real exchange rate, lower growth. Regarding the effect of undervaluation of the exchange rate on economic growth, the evidence is mixed and inconclusive. However, there is no evidence in the literature that Dutch disease reduces overall economic growth. Policy responses should aim at adequately managing the boom and the risks associated with it.