South-Western College Publishing - Economics  
The Dollarization of Ecuador
Subject Monetary policy
Topic International Finance
Key Words Monetary Policy, Exchange Rates, Economic Growth
News Story

The President of Ecuador, Jamil Mahuad, wants to replace the sucre, Ecuador's current national currency with the U.S. dollar. His plan won approval from Ecuador's central bank after three current board members resigned to protest this policy. President Mahuad decided to replace the sucre in an attempt to rescue Ecuador from its worst economic crises in 70 years.

Almost every major Latin American country has seen its currency weaken in the past few years. Some of these countries, like Brazil, responded by devaluing their currency. Argentina has linked its currency to the dollar. The value of the sucre currently floats in relation to the dollar and the sucre has lost 67 percent of its value in 1999, as well as a few percentage points in the first few days of 2000. Ecuador had proposed buying sucres now in circulation and replacing them with U.S. dollars. Sucres will then disappear except in the form of coins.

At the official exchange rate of 25,000 sucres to the dollar, Ecuadorian officials estimate that $450 million will be needed to accomplish the switch. Since the country's foreign reserves are in excess of $1.2 billion, there should not be any difficulty in accomplishing this. The estimate of $450 million does not consider savings or checking accounts. The government's plan is to restrict or delay redemption of these accounts by issuing dollar-denominated bonds as compensation for accounts in excess of $4,000.

The impact of the switch will be felt throughout the economy. Ecuador's central bank will lose control of monetary policy and its functions will be restricted to currency exchange. The International Monetary Fund wants to restart negotiations that have been underway for nearly a year to provide a $250 million loan for Ecuador.

The decision to replace the sucre has met some opposition. In addition to the resignations from the central banks, there are street protests and a call for a general strike to protest the government's policy.

(Updated February 1, 1999)

Questions
1. Why does Ecuador's central bank lose control of its monetary policy functions when it replaces the sucre with the U.S. dollar?
2. The government currently pegs the sucre at 25,00 to the dollar. What happens to domestic prices after the switch? What happens to the exchange rate?
3. The government claims that the switch to the dollar would help control inflation and promote foreign investment. How does having the U.S. dollar as Ecuador's currency help control inflation? How does it promote foreign investment? (Hint: investors worry when the value of a nation's currency has wide swings)
Source Larry Rohter, "Ecuador's 3 Top Central Bankers Quit Over Dollarization," The New York Times, January 12, 2000.

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