Assignment: Ecuador Dollarization
Ecuador Dollarization Mini Case Study
Dollarization is the replacement of a foreign country's currency with the U.S. dollar. Dollarization is different from pegging, when pegging, the foreign countries retain their local currencies. The decision to dollarize cannot be easily reversed as the country does not have a local currency anymore (Madura, 2015).
For example, the Gulf Cooperation Council (GCC: Saudi Arabia, United Arab Emirates, Bahrain, Qatar, and Omar) peg their local currencies to the U.S. dollar using a fixed exchange rate i.e. their currencies change up and down with the changes in the U.S. dollar; and accordingly their economies are affected by the U.S. economy. This also has an impact on their revenues are most of their oil exports are in U.S. dollar.
From 1990 to 2000 Ecuador's local currency, the sucre, depreciated around 97% against the U.S. dollar. The sucre weakness led to volatile interest rates, high inflation, and unstable trade conditions. In an effort to stabilize economic conditions and trade, Ecuador replaced the sucre with the U.S. dollar in 2000, and used it as its currency. By November of the same year, economic growth has increased, and in inflation decreased. So it seems that dollarization had a favorable effect (Madura, 2015).
Read
Berríos, R. (2006). Cost and benefit of Ecuador's dollarization experience. Perspectives on Global Development & Technology,5(1/2), 55-68. doi :10.1163/156915006777354491
Based on the required readings and research, discuss:
1. Why did Ecuador choose to dollarize?
2. Fast forward: What is the impact of the dollarization on the country today? In retrospect, was it a good decision to dollarize?
3. How important is transparency of the financial system when dollarizing?
4. What is the combined impact of dollarization and low revenue (due to decreasing oil prices) on the Ecuadorian economy today?
Source used in the development of the Ecuador Dollarization Mini Case Study (not required reading):
Madura, J. (2015). International financial management (12th ed.). Stamford, CT: Cengage Learning.