Question

Can you think of any major disadvantages to dollarization? How would a central bank work in a country that has dollarized?

a) Loss of monetary policy control; central bank focuses on financial stability.
b) Enhanced financial stability; central bank regulates interest rates.
c) Increased economic independence; central bank adjusts fiscal policy.
d) Flexible monetary policy; central bank controls inflation and unemployment.

Answer 1

The major disadvantage of dollarization is a country's loss of control over its monetary policy. In a dollarized country, the central bank's role changes to focusing primarily on maintaining financial stability rather than managing currency or monetary policy.

Step-by-step explanation:

When a nation adopts dollarization, it means it uses another country's currency, such as the U.S. dollar, in place of its own. One major disadvantage of dollarization is the loss of monetary policy control. This means the country's central bank cannot set its own interest rates or directly control inflation and unemployment rates, as these are now largely determined by the economic policies of the United States.

In a dollarized economy, the function of the central bank shifts away from traditional monetary policy tasks. Instead, it mainly focuses on ensuring financial stability. This involves acting as a lender of last resort to banks and safeguarding the banking system. However, it no longer manages the national currency or conducts independent monetary policy.