The Pros And Cons Of Dollarization

Dollarization is the replacement of a countries domestic currency with that of a foreign currency. Dollarization has occurred in several countries including, but not limited to, Panama, El Salvador, and Ecuador. For countries with volatile currencies, dollarization offers them the ability to stabilize their economy. While dollarization has its pros, it is not without its cons, and for Ecuador, this is no exception. In my initial discussion, I believed that dollarization was a positive move for Ecuador; I still feel this way, and now that I have gained a bit more knowledge concerning the macro economy system, I understand how dollarization aided in Ecuador’s economy to stabilize. However, with all the positives associated with Ecuador’s adoption …show more content…
Ecuador’s economic crisis was extensive, but the move to dollarization reduced the inflation rate significantly from 96.1% in 2001 to 3.76% in 2015. With a lower inflation rate came an expectation of higher investment and a faster rate of economic growth. Full dollarization also benefits Ecuador by eliminating the exchange rate risk which offers advantages in the exporting and importing division of a country. With the elimination of domestic money, there is no longer any risk of a domestic money crisis. There is no danger of depreciation or capital outflows provoked by the fear of devaluation. There will also be a reduction in the interest rate and subsequently an increase in domestic investments. Another positive move to full dollarization is fiscal discipline. The Federal Reserve, not Ecuador, has control over the money supply. Ecuador can no longer print their own money to finance any deficits they may incur; the money the government receives can only come from from taxes, profits and borrowing. This is undoubtedly viewed as a positive, as over printing currency typically leads to …show more content…
In fact, one of the positives to full dollarization can also be viewed as negative – the loss of fiscal control. Ecuador’s government has lost any and all control over fiscal discipline for their country. They will no longer have the capability to influence external shocks or stabilize the country in the wake of an economic crisis. The Federal Reserve now has full authority over Ecuador’s money supply and interest rates. Full dollarization places a restriction on the role of monetary authority as the lender of last resort; because printing money is no longer an option, the central bank will need to find alternative measures to aid in times of financial difficulties. This can lead to more frequent bank run-ons and financial instability within the banking system. An additional negative facet of full dollarization is the loss of seignorage, the difference between how much money is worth and how much it costs to manufacture it. If money is worth more than it costs to produce, the government can use the excess money as revenue. Those revenues can then be subsequently used to finance various