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The dollarization paradox in Cambodia: Network externalities matter

Kheng, Veasna and Pan, Lei and McKinley, Justin (2021): The dollarization paradox in Cambodia: Network externalities matter.

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Abstract

The increased use of foreign currency as legal tender in Cambodia has been contrary to the general belief that macroeconomic and political stability help reduce dollarization. We provide so far the first explanation for this counterfactual phenomenon. In doing so, this paper develops a theoretical model based on the framework of Uribe (1997) by including a dollar pricing index to amplify the network effects of using a foreign currency (denoted dollar). The dollar pricing index, a proportion of an economy denominated by the dollar, reduces its transaction cost, thus increasing its usage in the economy. This increased use of the dollar further improves the experience of using it, resulting in higher usage of the dollar in the price quotation. The positive interaction of using the dollar as a unit of account and a means of payment causes dollarization to continue to rise, even though the economy has achieved low inflation and political stability.

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