The Dollarisation Paradox in Cambodia: Network Externalities Matter

Kheng, Veasna and Pan, Lei (2021): The Dollarisation Paradox in Cambodia: Network Externalities Matter.

Abstract

The increase in dollarisation in Cambodia has been contrary to the general belief that macroeconomic and political stability help reduce dollarisation. We provide so far the first explanation for this counterfactual phenomenon. In doing so, this paper develops a theoretical model based on the framework ofUribe (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 the dollar’s transaction cost, thus increasing its usage in the economy. This increased use of the dollar further improves the experience of using it, hence results in higher usage of dollar in the price quotation. The positive interaction of using the dollar as a unit of account and a means of payment causes dollarisation continues to rise, even though the economy has achieved low inflation and political stability.

• Item Type: MPRA Paper
• Language: English
• Keywords: Dollarisation; Dollar pricing index; Network externalities
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Camera, G., Craig, B., and Waller, C.J. (2004). Currency competition in a fundamental model of money. Journal of International Economics, 64(2), 521–44.

Castellares, R. and Toma, H. (2019). Effects of a mandatory local currency pricing law on the exchange rate pass-through. BIS Working Paper No. 785. Available online at: https://www.bis.org/publ/work785.pdf

Clements, B. and Schwartz, G. (1993). Currency substitution: The recent experience of Bo- livia. World Development, 21(11), 1883–1893.

Craig, B. and Waller, C.J. (2004). Dollarization and currency exchange. Journal of Monetary Economics, 51(4), 671–689.

De Zamaroczy, M. and Sa, S. (2002). Macroeconomic adjustment in a highly dollarized economy: The case of Cambodia. IMF Working Paper, WP/02/92.

Duffy, J. and Ochs, J. (2002). Intrinsically worthless objects as media of exchange: Experi- mental evidence. International Economic Review, 43(3), 637–673.

Engineer, M. (2000). Currency transactions costs and competing fiat currencies. Journal of International Economics, 52(1), 113–136.

Guidotti, P. E. and Rodriguez, C. A. (1992). Dollarization in Latin America: Gresham’s law in reverse? IMF Staff Papers, 39(3), 518–544.

Khou, V. (2012). Functionality of the monetary plurality in Cambodia. Unpublished PhD dissertation. Lyon: Université Lumière Lyon.

Kiyotaki, N. and Wright, R. (1989). On money as a medium of exchange. Journal of Political Economy, 97(4), 927–954.

Kubo, K. (2017). Dollarization and De-dollarization in Transitional Economies of Southeast Asia. Springer.

Lucas, R.E. (1982). Interest rates and currency prices in a two-country world. Journal of Monetary Economics, 10(3), 335–359.

Matsuyama, K., Kiyotaki, N. and Matsui, A. (1993). Toward a theory of international cur- rency. Review of Economic Studies, 60(2), 283–307.

Melvin, M. and Fenske, K. (1992). Dolarization and monetary reform: Evidence from the Cochabamba region of Bolivia. Revista de Análisis Económico–Economic Analysis Re- view, 7(1), 125–138.

Menon, J. (2008). Cambodia’s persistent dollarization: Causes and policy options. ASEAN Economic Bulletin, 25(2), 228–237.

National Bank of Cambodia (2016). Dollarization in Cambodia: Evi- dence from a survey conducted in 2014-2015. Available online at: https://www.nbc.org.kh/download_files/research_papers/english/9445Dollarization inCambodiaasofOctober20.pdf

Rolnick, A.J. and Weber, W.E. (1986). Gresham’s law or Gresham’s fallacy? Journal of Political Economy, 94(1), 185–199.

Samreth, S. (2011). An empirical study on the hysteresis of currency substitution in Cam- bodia. Journal of Asian Economics, 22(6), 518–527.

Tandon, A. and Wang, Y. (2003). Confidence in domestic money and currency substitution. Economic Inquiry, 41(3), 407–419.

The New York Times. (2016). In Cambodia, the Ghosts Prefer Dollars. Available online at: https://www.nytimes.com/2016/04/09/world/asia/cambodia-qingming-festival- ghosts-prefer-dollars.html

Trejos, A. and Wright, R. (1995). Search, bargaining, money, and prices. Journal of Political Economy, 103(1), 118–141.

Uribe, M. (1997). Hysteresis in a simple model of currency substitution. Journal of Monetary Economics, 40(1), 185–202.

Valev, N. T. (2010). The hysteresis of currency substitution: Currency risk vs. network exter- nalities. Journal of International Money and Finance, 29(2), 224–235.