Deposit dollarization in emerging markets: modelling the hysteresis effect

Abstract

We apply empirical modelling set-ups developed to capture the hysteresis effect in the data on deposit dollarization in a cross-section of emerging market economies. Specifically, we estimate a nonlinear relationship that determines two equilibrium levels of deposit dollarization depending on the current value of dollarization and previous episodes of sharp depreciation of the national currency over the past five years. When exchange rates are stable, convergence to a higher equilibrium level of dollarization begins when the 45–50% thresh-old of deposit dollarization is exceeded. We estimate the model for short-run dynamics of dollarization and find that the speed of convergence to the higher equilibrium implies quarterly increases of 1.2–3 percentage points in the ratio of foreign currency deposits to total deposits.