Dollarization of Liabilities in Non-tradable Goods Sector

This paper questions the motivation of dollar indebtedness by firms of the non-tradable good sectors in a period of exchange rate pressure. Given the structure of banks' indebtedness and protection of banks' foreign lenders, a dollar denominated loan may allow firms to insure (partially) against the risk of an early liquidation of their projects if they turn out to be poor. Then it is shown that under dollarization of liabilities the government may be urged to soften monetary policy to induce a real appreciation that supports the domestic banking system. Therefore, it might be constrained in its ability to enforce an efficient regulatory policy.