Monetary policy, financial dollarization and agency costs

This paper models an emerging economy with financial dollarization features within an optimizing, stochastic general equilibrium setup. One key result in this framework is that unexpected nominal exchange rate depreciations are positively correlated with the probability of default by borrower firms and turn out to be a powerful mechanism to affect aggregate consumption. Throughout the monetary policy evaluation exercises performed, the sign of the unexpected depreciation is positively correlated to the real value of assets and negatively correlated to aggregate consumption. This result supports the idea that unexpected exchange rate depreciations are contractionary and not expansionary if dollarization and agency costs in the financial sector are considered.