Dollarization and the multiple currency phenomenon in Lao PDR : costs, benefits and policy options

The multiple currency phenomenon (MCP) in Lao PDR takes the form of the use of foreign currencies such as dollars and baht in the presence of a domestically issued currency. The MCP has both costs and benefits. The costs include the social loss associated with seigniorage, the inability to conduct an independent monetary policy and the relative ineffectiveness of the exchange rate as an adjustment mechanism. The benefits of the MCP include the discipline imposed on the government by limiting its capacity to finance spending through inflation tax, and the stability and certainty induced by an effectively fixed exchange rate. Since the costs appear to exceed the benefits, how should the Government of Lao PDR respond? Enforcing the use of the kip is not the answer, and may well be counter-productive. This is because the MCP is not the problem, but is merely a symptom. The problem is a lack of confidence in the kip, whilst the symptom is the use of another currency such as the dollar or baht. The causes of the problem emanate from an underdeveloped monetary system, macroeconomic instability, and weak legal and institutional systems. These are the problems that need to be addressed directly. When these problems are addressed, then the symptom, which is the MCP, will also cease to be a constraint.