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CFA Level I · CFA Level I Exam · Capital Flows and the FX Market

A country has formally dollarized, adopting a foreign country's currency as its legal tender. Compared with a currency board, the dollarizing country most likely:

The dollarizing country gives up independent monetary policy and seignorage. Because it uses a foreign currency, it cannot devalue, and its central bank cannot create money to rescue banks. A currency board still keeps a domestic currency, although it is backed fully by foreign reserves.

  1. Aretains the ability to devalue its currency if competitiveness falls
  2. Bgives up its own monetary policy and the ability to earn seignorageCorrect
  3. Ccan act as lender of last resort to its banks by printing currency

Explanation

Formal dollarization means the country uses another nation's currency, so it has no domestic currency to issue. It loses independent monetary policy and seignorage revenue, and cannot print money to act as lender of last resort. Devaluation is impossible since no domestic currency exists. A currency board at least retains a domestic currency.

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