Asymmetric monetary union and real volatility

Abstract

This study gives a non-traditional framework for the evaluation of the convenience of an asymmetric monetary association (such as dollarization), from the point of view of the country that gives up its monetary sovereignty. In the analytical part we discuss the relationship between nominal volatility, real volatility and country risk. Given the social loss function of the policymaker, we determine the necessary conditions for dollarization to improve social welfare. We concentrate in the analysis of two main aspects: 1) the degree of synchronization existing between the cycle of the leader and associated country, and 2) the effect and relative importance of the trade and financial channels. We perform an application of our analytical framework to the case of Argentina using the coefficient of cyclical correlation, calculated for four different methodologies. The effect and relative importance of the financial channel and the trade channel were extracted from the impulse-response functions and variance decompositions of a VEC Model.