Dollarisation is a form of currency substitution. It is the use of a foreign currency instead of a domestic currency. Europeans have taken advantage of this and most countries within the continent now use the Euro and certain countries outside Europe use the US dollar instead. Yet dollarisation can also be when a country pegs its currency to another/foreign currency and uses the US dollar to determine their exchange rate. Finally, the term dollarisation can also refer to a situation when residents of a country hold their assets in a foreign currency, even if that currency is not able to be used in their own country. I believe that dollarisation can be beneficial to a country depending on the type. For this essay I will focus on dollarisation where countries adopt the USD. For this type, overall dollarisation is not as beneficial due to countries being exposed to the fiscal and monetary policy of US without having any say in them but also, they are susceptible to other sanctions

Dollarisation is beneficial to a country as it reduces the cost of trade thus increasing the balance of payments. Lower cost of trade occurs due to businesses being able to easily compare prices across different markets meaning that pricing is similar and low for consumers. If firms from different countries are trading similar goods, they are able to trade with each other and possibly benefit from economies of scale. Together with trade agreements also possibly being implemented, the low cost of trade means that the country will have greater imports and exports, increasing the current account in the balance of payments. Furthermore, with a stable currency this means that investors will be attracted to the country. This has multiple benefits for the economy such as being an injection into the circular flow of income causing economic growth but also investment given to certain domestic businesses can help them increase the quality of their goods through possible research and development. This leads to the domestic goods becoming internationally competitive which leads to exports becoming greater than imports reducing a current account deficit and encouraging further growth. This can also create a multiplier effect by causing more jobs to be created so less unemployment and economic growth will continue to occur over time.

As mentioned above, dollarisation will also make the currency more stable and lower the cost of borrowing which will attract investors but importantly investment into assets and give the country access to international financial markets. This foreign direct investment may lead to investors also setting up businesses in the country which may provide new goods and provide variety for the country increasing their standard of living as they are consuming more luxury goods, increasing development.  With more businesses created this also leads to more jobs created which benefits the country greatly as it means that people earn higher incomes also increasing their standard of living as they are able to afford more luxury goods which increases development. Yet, it must be highlighted that foreign investors only invest when they perceive the risk of providing loans low means that if the regime is corrupt and investment is not protected under the rule of law then it is unlikely to occur. There is also less government intervention with the exchange rate. This may provide confidence to foreign investors who will see that the exchange rate is unlikely to fluctuate much. This means that there is a decrease in speculation which is when investors buy their assets at a low exchange rate and sell at a high exchange rate to get a better return. 

Yet despite the multiplier effect occurring, as mentioned before, inflation comes along with it. Demand pull inflation has many negative consequences such as firms being forced to increase their wages as workers are demanding them to increase in line with inflation, thus countries should find ways of preventing and reversing it. One way this can be achieved is by using monetary policy such as setting interest rates to encourage a decrease in consumption. However, this is not possible with dollarisation as countries are unable to use their own monetary policy but have to instead follow that of the currency they are using. This may restrict the country as they may have to use other methods that result in a decrease in economic growth or may have to deal with inflation. Not being able to use monetary policy is also not beneficial as it means that the government is not able to use quantitative easing to take out bonds easily to fund their spending easily meaning that the country may get further into debt.

Finally, utilising another currency such as the dollar means that the country is likely to be affected by external shocks in the US as this may appreciate or depreciate the value of the local/pegged currency. For example, at the beginning of the 2008 financial crisis the value of the dollar depreciated but towards the end it appreciated greatly. This fluctuation, along with the fact that there was a crisis, deterred investors from the dollar and proves the lack of economic independence a country may have. However, the appreciation can lead to less demand for the goods in the country which decreases profit for local firms and the external shocks that cause them can have a poor effect on the country. This is due to them occurring unexpectedly, with the potential to ruin the country, especially if there is a severe change in the exchange rate. 

Overall, dollarisation where countries give up their sovereignty over their own currency is not good as it leads to a lack of economic independence and can cause inflation as well as negatively affect the balance of payments. There are certain benefits such as economic growth and increased foreign investment, but this does depend upon whether the currency remains stable and no external shocks lead to the value of the dollar changing, thus dollarisation has more negative than positive consequences.