Compare the monetary policy of the 50 states that make up the United States to the exchange rate regime of dollarization.

Question

What will be an ideal response?

Answer 1

In the United States, each of the 50 states has basically turned over monetary policy to the Federal Reserve and its FOMC. Each state could have its own monetary policy (print its own currency) and through that policy try to have its own target interest rate. The problem lies in the fact that if capital could flow between the states, the states would either have to have a fixed exchange rate, which means giving up domestic monetary policy, or have flexible exchange rates. Also, as the 50 states use the same currency the integration into markets across the states is far greater allowing for greater efficiency. When a country adopts the exchange rate regime of dollarization, it basically gives up its own currency and uses the currency of another country, much like the states in the U.S. The advantages include greater integration into world markets, no worries regarding exchange rate devaluations and lower risk premiums. Finally, each state in the U.S. has surrendered monetary policy to the FOMC. A country that adopts dollarization basically gives up its own monetary policy and takes the monetary policy of the country whose currency is being used like it or not!