A general equilibrium model with dollarization for the Peruvian economy

This paper develops a calibrated stochastic dynamic general-equilibrium model for the Peruvian economy that can be used for the design and analysis of monetary policy. The model includes a second currency that partially replaces the domestic currency in its functions as a unit of account, medium of exchange, and store of value—a phenomenon known in the economic literature as partial dollarization. Real, nominal, and financial rigidities are also included to replicate certain empirical regularities observed in Peruvian macroeconomic data. The model reproduces the main stylized facts of the Peruvian economy relatively well. It also demonstrates how dollarization reduces the effectiveness of monetary policy in influencing output and increases the vulnerability of economic activity to external shocks. Furthermore, it shows how foreign exchange intervention reduces this vulnerability. In addition, experiments are conducted that highlight the importance of central bank credibility for controlling inflation. (Audio: Department of Economic Publications)