Ecuador: The Road to Dollarization and Beyond

This paper discusses the use of the dollar currency in Ecuador, how it reached this stage, and how it affects the economy.

This paper identifies five persistent factors that have determined the historical trajectory in Ecuador’s exchange-rate policy and threatened its long-term macroeconomic stability: (a) chronic inflation, (b) over-dependence on commodity exports, (c) excessive borrowing, (d) institutional weaknesses in the financial system, and (e) weak public administration. It assesses the merits of dollarization by discussing to what extent these problems have been mitigated or solved. The rest of the paper is organized as follows: Section 1 provides an historical overview of the important events surrounding Ecuador’s exchange rate policy, beginning with the adoption and management of the floating rate in early 1990s, leading up to dollarization in the year 2000, and highlighting the state of affairs in the country since then; Section 2 describes the process by which Ecuador implemented dollarization; Section 3 provides an analysis of the pros and cons of dollarization in Ecuador; Section 4 discusses whether Ecuador really had any choice but to dollarize, given the option of adopting a currency board instead; and in Section 5, the writer provides some concluding comments.
“Ecuador is one of the 15 countries in the world today that uses the U.S. dollar as its official domestic currency and legal tender . The case of Ecuador’s dollarization is unique for two reasons; first, this is by far the largest country to fully dollarize its economy, and second, the purpose of dollarization was not to reap the benefits of a regional or trade-based currency union, but to provide quick stabilization to a volatile macroeconomic environment. The Ecuadorian sucre experienced several different exchange rate systems on the road to dollarization, including a fixed exchange rate regime during the seventies, an unwieldy floating rate system in the late eighties and early nineties featuring four different exchange rates simultaneously in operation, a unified and managed floating rate mechanism subject to a crawling peg band for most of the nineties, and finally, a free float in 1999. During this period, Ecuador experienced a steady increase in the level of unofficial, spontaneous dollarization, to the extent that the economy was operating in a dual-currency environment. Full, official and formal dollarization was declared in January 2000, at a time when the country was suffering from the worst recession in its independent history, a severe banking crisis, and hyperinflation.”