Masterthesis

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國立清華大學
National Tsing Hua University
Currency Reform: A Case of Dollarization in
Ecuador and El Salvador
貨幣改革：以厄瓜多與薩爾瓦多的美元化為例
By
Esmeralda Eugenia Posada Torres
（伯莎達） 101077430
Advisor
Stephen Jui-Hsien Chou (周瑞賢)
Master thesis Presented to the College of Technology Management National
Tsing Hua University, Hsinchu, Taiwan, R.O.C
In Partial Fulfillment of the Requirements for the Degree of International
Master in Business Administration (IMBA)
June 2014

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Abstract
Determining which monetary policy to implement in a country is of utmost
importance for the well-being of the economy. This thesis examines
dollarization, when a country chooses to use another major currency as a
legal tender, while the central bank stops issuing local currency. Dollarization
is a monetary policy that only a few countries have taken, and the majority of
them are small developing countries, which benefit from the use of a stable
currency.
The focus of this thesis is to study the cases of Ecuador and El Salvador,
which are two of the biggest economies that have officially dollarized. An
analysis of the costs of dollarizing such as losing independent monetary policy,
losing seigniorage revenue, and losing the lender of last resort is weighted
against the benefits of reducing the currency risk, lowering the cost of credit,
and keeping prices stable. Next, findings on how dollarization affected GDP
growth, inflation rate, and interest rates in these two countries are shown. The
results show that, as expected, dollarization managed to lower interest rates
as well as inflation rate, however, for the GDP growth Ecuador’s GDP grew at
a faster pace after dollarization, while El Salvador’s decreased.

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Table of Contents
ABSTRACT...........................................................................................................................................2
1. INTRODUCTION ........................................................................................................................5
1.1. DOLLARIZATION...................................................................................................................................6
1.2. REQUIREMENTS FOR DOLLARIZING..................................................................................................8
1.3. ECUADOR...............................................................................................................................................8
1.4. EL SALVADOR.......................................................................................................................................9
2. COSTS AND BENEFITS OF DOLLARIZATION..................................................................11
2.1. COSTS.................................................................................................................................................. 11
2.1.1. Losing Seigniorage Revenue...................................................................................................11
2.1.2. Losing the Lender of Last Resort..........................................................................................12
2.1.3. Losing Independent Monetary Policy.................................................................................13
2.2. BENEFITS ........................................................................................................................................... 14
2.2.1. Eliminating Currency Risk.......................................................................................................14
2.2.2. Lowering the Cost of Credit.....................................................................................................15
2.2.3. Other Benefits of Dollarization .............................................................................................16
3. FINDINGS FOR ECUADOR AND EL SALVADOR..............................................................18
3.1. GDP GROWTH................................................................................................................................... 18
3.1.1. Ecuador............................................................................................................................................18
3.1.2. El Salvador......................................................................................................................................20
3.1.3. Inflation Rate.................................................................................................................................21
3.1.4. Interest Rates.................................................................................................................................23
4. COMPARISON OF ECUADOR AND EL SALVADOR WITH THEIR NEIGHBOR
COUNTRIES .......................................................................................................................................26
4.1. COMPARISON OF ECUADOR’S, PERU’S, COLOMBIA’S AND CHILE’S GDP GROWTH RATE,
INFLATION RATES AND INTEREST RATES. ................................................................................................ 26
4.1.1. GDP growth rate of Ecuador compared to the GDP growth rate of Colombia,
Peru and Chile................................................................................................................................................26
4.1.2. Inflation rate of Ecuador compared to the inflation rate of Colombia, Peru,
and Chile...........................................................................................................................................................28
4.1.3. Lending interest rate of Ecuador compared to the lending interest rate of
Colombia, Peru, and Chile.........................................................................................................................30
4.2. COMPARISON OF EL SALVADOR’S, HONDURAS’, GUATEMALA’S AND NICARAGUA’S GDP
GROWTH RATE, INFLATION RATES, AND INTEREST RATES................................................................... 32
4.2.1. GDP Growth Rate of El Salvador compared to the GDP Growth Rate of
Honduras, Guatemala, and Nicaragua...............................................................................................32
4.2.2. Inflation Rate of El Salvador compared to the Inflation Rate of Honduras,
Guatemala, and Nicaragua......................................................................................................................34
4.2.3. Lending Interest Rate of El Salvador compared to the Lending Interest Rate of
Honduras, Guatemala, and Nicaragua...............................................................................................36
5. CONCLUSION ............................................................................................................................38
REFERENCES.....................................................................................................................................41

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List of Tables
Table 1: Ecuador's GDP Growth Rate Before Dollarization.......................................... 19
Table 2: Ecuador's GDP Growth Rate After Dollarization............................................. 19
Table 3: El Salvador's GDP Growth Rate Before Dollarization.................................... 20
Table 4: El Salvador's GDP Growth Rate After Dollarization....................................... 20
Table 5: Inflation Rate Before and After Dollarization................................................... 22
Table 6: Lending Interest Rates............................................................................................... 24
Table 7: GDP Growth before dollarization in Ecuador................................................... 27
Table 8: GDP Growth after dollarization in Ecuador....................................................... 27
Table 9: Inflation Rate Before Dollarization in Ecuador................................................ 28
Table 10: Inflation Rate After Dollarization in Ecuador ................................................ 29
Table 11: Lending Interest Rate Before Dollarization in Ecuador............................. 30
Table 12: Lending Interest Rate After Dollarization in Ecuador................................ 31
Table 13: GDP Growth Before Dollarization in El Salvador.......................................... 32
Table 14: GDP Growth After Dollarization in El Salvador............................................. 33
Table 15: Inflation Rate Before Dollarization in El Salvador....................................... 34
Table 16: Inflation Rate After Dollarization in El Salvador .......................................... 35
Table 17: Lending Interest Rate Before Dollarization in El Salvador....................... 36
Table 18: Lending Interest Rate After Dollarization in El Salvador.......................... 37
List of Figures
Figure 1: GDP Growth Rate ....................................................................................................... 18
Figure 2: Inflation Rate............................................................................................................... 21
Figure 3: Lending Interest Rate............................................................................................... 23
Figure 4: GDP Growth.................................................................................................................. 26
Figure 6: Lending Interest Rates............................................................................................. 30
Figure 7: GDP Growth.................................................................................................................. 32
Figure 9: Lending Interest Rate............................................................................................... 36

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1. Introduction
The exchange rate regimen a country choses has a big impact on its
economy, and there is no best regimen. Different countries might benefit from
different exchange rate regimen according to their own unique circumstances.
The two main systems are free floating and fixed. Dollarization is the extreme
side of the fixed exchange rate system, where a country chooses to use
another major currency as a legal tender, while the central bank stops issuing
local currency. Dollarizing is an extreme measure that only a few countries
have taken.
According to Parodi (2001), there are 30 countries that use another country’s
currency as a legal tender: only 15 of them are independent. The countries
that choose to officially dollarize are usually small developing countries that
have strong ties with the anchor country. The countries with the largest
populations and GDP that have officially dollarized are Ecuador, El Salvador,
and Panama. The three of them have the U.S as their largest export and
import partner. El Salvador’s exports to the U.S are 47.3%, and imports from
the U.S are 35.4%, and Ecuador exports 35.7% to the U.S, and imports
28.4% from the U.S1.
This study focuses on Ecuador and El Salvador because they dollarized at
around the same time, 2000 and 2001, but they dollarized for different
reasons and under different macroeconomic circumstances. Ecuador
dollarized during a banking crisis while El Salvador dollarized under stable
macroeconomic conditions.
1 Ecuador’s and El Salvador’s Exports and Imports for 2013 according to the CIA
World Factbook.

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The first section of this study is an introduction of dollarization, as well as an
introduction of the macroeconomic circumstances that led Ecuador and El
Salvador to dollarize. Section two focuses on the theoretical arguments that
economists have for and against dollarization, including the costs and the
benefits. Section three shows the findings after fourteen and thirteen years of
dollarization. Section four is a cross comparison between Ecuador and its
neighbor countries, and El Salvador and its neighbor countries. Lastly, section
five concludes this thesis.
1.1.Dollarization
Countries often search for ways to promote economic stability, and a way of
doing this is by achieving currency stability. Developing countries often suffer
currency fluctuations, which leads to lack of investment because of the
uncertainty that investing in them represents. If people decide to invest in
these countries, they often require a high premium for taking this risk. Since
some developing countries want to promote confidence to investors, they
often peg their currency to a more stable currency to encourage foreign
investment. Nevertheless, pegging the currency does not always reduce the
risk because there is always the possibility that the government can abandon
the peg. Consequently, some countries opt for a more definite option, which is
to replace their local currency with a more stable currency; this process is
called “dollarization”.
There are two types of dollarization. The first is “unofficial dollarization”, which
happens when citizens of a country decide to hold some or all of their assets
in a strong foreign currency, as a result of a lack of confidence in the local
currency. Parodi (2001), points out the case of Peru, where companies are

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not able to get long-term loans in the local currency, the sol, and they have to
either borrow in U.S dollars or get short-term loans in soles. If they borrow in
Dollars, a depreciation of the sol might lead them to bankruptcy. However, if
they borrow in short term-loan of soles, a liquidity problem might make them
unable to borrow again and go bankrupt as well. This causes a mismatch in
maturity periods because long-term investments are being financed with
short-term loans. As an alternative, investors prefer to buy dollars and operate
with them, which makes Peru a country with a high degree of unofficial
dollarization.
The second type is “de jure” or “official dollarization”, which is when a country
chooses to use another major currency as legal tender. Most officially
dollarized countries use the U.S dollar, but in some cases other major
currencies such as the Euro or Australian dollars are used. According to
Chang (2000), two exchanges need to be enacted: The domestic monetary
base that is local currency plus banks cash reserves would be redeemed for
U.S dollars at a fixed exchange rate, and all contracts denominated in local
currency would be transformed into contracts in U.S dollars.
This study discusses official dollarization, and focuses on Ecuador and El
Salvador because alongside Panama they are the biggest economies in the
world that have officially dollarized, but unlike Panama, which has been fully
dollarized since 1904, Ecuador and El Salvador’s dollarization is relatively
recent. The former officially dollarized in 2000, while the latter has been
officially dollarized since 2001. According to Parodi (2001), after these two
countries dollarized other countries in the region such as Guatemala, Peru,
and Nicaragua debated whether to dollarize, but ultimately decided against it.

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1.2.Requirements for Dollarizing
When El Salvador and Ecuador were considering dollarization, there were
talks of a forgone seignorage. There was discussion of whether an agreement
with the U.S sharing seignorage could be made. However, an agreement was
never reached, and Ecuador and El Salvador decided to dollarize unilaterally.
Consequently, The U.S would not consider the effects that their monetary
policy would have on the economies of dollarized countries.
According to Haussmann and Powell (1999), in order for a country to dollarize,
the following steps should be taken: first, buy back the currency in circulation
and convert it to U.S dollars. To achieve this, the countries need to have
enough international reserves. Second, all the bonds in circulation need to be
retired. Finally, they need to retire all of the base money including reserve
requirements of the bank.
1.3.Ecuador
On January 9th 2000, President Jamil Mahuad announced the decision to
officially dollarize Ecuador. Two weeks later, he was forced to resign by
indigenous Ecuadorians and military protesters, however the new president
Gustavo Novoa continued with the process of dollarization (Araujo).
The decision to dollarize was due to serious problems in the economy;
Ecuador’s last good year before dollarization was 1994, when it grew 4%. In
1995, Ecuador had a border dispute with Peru, which increased military
spending and led to budget deficit. Ecuador continued to face problems, and
in 1997, had a loss of 13 percent of the GDP, due to El Niño, which damaged
infrastructure and caused a big loss of crops. Continued fall of oil prices, one
of Ecuador’s main exports, and the serious problems in the banking sector

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made the situation worse, Fischer (2000). In 1999, by the time Mahud
announced dollarization, the sucre, Ecuador’s currency, had depreciated
almost 80 percent in the past 16 months, inflation was high, and the banking
sector saw liquidity problems, which lead to a freeze on bank deposits, and a
default on external debt payments Quispe-Agnoli and Whisler (2006). In an
attempt to stabilize the economy, President Jamil Mahaud announced the
country was going to fully dollarize. Two weeks later, he was deposed but
when Gustavo Novoa took office, he continued with the dollarization process,
fixing the sucre at 25,000 per U.S dollar. He also introduced the economic
transformation law (Ley de Transformacion Economica). This law provided
incentives for investors, and encouraged the privatization of state enterprises.
As Quispe-Agnoli and Whisler 2006 explain over the year, the central bank
repurchased almost all the outstanding stock of sucres, and all bank accounts
were converted to dollars. The IMF also signed an agreement with the
Ecuadorian government to help them support stability.
1.4.El Salvador
El Salvador suffered a civil war that lasted for 12 years, from 1980 to 1992.
After the peace agreement was signed, El Salvador focused on implementing
reforms to rebuild and stabilize the economy. According to the IMF (1998),
these reforms included tax restructuring, privatization of financial systems and
state enterprises, and financial and trade liberalization. In 1993, El Salvador
fixed the exchange rate at 8.75 colones per U.S dollar. Due to the end of the
civil war and because of the reforms mentioned above, El Salvador was able
to foster stability. According to statistics from the World Bank, El Salvador was
able to lower its inflation rate from 11.2 percent in 1992 to 2.3 percent in 2000.

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Real interest rates however, were high at 10.5 percent in 2000 according to
World Bank statistics. As reported by Quispe-Agnoli and Whisler (2006),
growth averaged 6 percent between 1990 and 1995, but due to hurricane
Mitch, which caused severe damage throughout the country, growth declined,
averaging 3.7 percent between 1998 and 2000.
With a stable banking system, stable growth, and low inflation President
Francisco Flores decided to dollarize. In January 2001, the Salvadoran
Government implemented the Monetary Integration Law (Ley de Integración
Monetaria), which kept the fixed exchange rate at 8.75 colones per U.S dollar.
The dollar became the only unit of account in the financial system, while
colones were still accepted until they slowly were fully replaced by U.S dollars.
The decision to dollarize came because El Salvador’s economy was strongly
tied to the U.S economy; two thirds of its exports went to the U.S, and big part
of El Salvador’s GDP 13.3 % in 2001, came from the remittances2 that
Salvadorans living in the U.S send to their relatives in El Salvador. Other
arguments were that it would lower interest rates, increase foreign investment,
and decrease transactions costs of international trade.
2
Remittance is a transfer of money by a foreign worker to an individual in his or her
home country, in the case of El Salvador most remittances come from the U.S.

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2. Costs and Benefits of Dollarization
The decision to dollarize has benefits as well as costs for the country
undertaking dollarization. The magnitude of these costs and benefits are
determined on the individual basis. Bencivenga, Huybens and Smith (2001)
talk about the optimal prerequisite for a country to dollarize is to have a highly
integrated financial market with the anchor country, otherwise dollarization
might bring volatility in the economy. They complement Mundell’s (1961)
study of optimal currency area, according to this theory countries that share
strong economic ties might benefit from a common currency. This common
currency would bring closer economic integration and would facilitate trade.
2.1.Costs
2.1.1. Losing Seigniorage Revenue
One of the consequences that a country accepts when it dollarizes is that it
gives up the seigniorage revenue. Seignorage is the difference between the
value of money and the cost a country incurs to produce it. When a country
dollarizes the country no longer issues money so this revenue is lost. The cost
of seignorage will depend on the amount a government relies on printing
money to finance government spending. For example, Chang (2000) shows
the amount that Argentina, Brazil and Mexico have relied on seignorage. In
Argentina, money creation is only 1.7 percent of the total government revenue,
while in Brazil is almost 9 percent, and in Mexico is 4.7 percent. According to
these statistics, the foregone seignorage revenue if these countries choose to
dollarize, would be quite large for Brazil while Argentina would incur
insignificant costs. Losing seignorage revenue might be beneficial for some

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countries in the sense that it might make governments choose better fiscal
policies instead of relying on this revenue to finance their spending.
2.1.2. Losing the Lender of Last Resort
A country that decides to dollarize will face costs when the central bank is no
longer able to act as a lender of last resort when the banking sector faces
liquidity problems. When countries have their own currency, the central bank
has the ability to print money. If private banks face bank runs or liquidity
problems, the central bank is able to provide credit to these banks by issuing
money. This allows private banks to meet their needs while the crises passes,
and later they are able to repay the central bank. However, this is not a
unique problem to dollarized economies; countries with fixed exchange rate
also face this problem, since they are committed to maintaining a fixed
exchange rate and the central bank cannot print money when private banks
have liquidity problems.
Dollarized countries as well as countries with a fixed exchange regime are
able to mitigate this risk by securing lines of credits from abroad that could be
drawn in the case of a banking crisis Chang (2000). Another way is to reserve
funds from taxes or other revenues Calvo (2001), and to require banks to
keep a high percentage of their deposits in liquid dollar instruments, issued by
Triple-A borrowers, which will make the costs low because banks will receive
income from them Hinds (1999).
Quispe-Agnoli and Whisler (2006) talk about the fact that in a dollarized
economy, the central bank cannot act as a lender of last resort, might make
banks runs less likely and reduce volatility because consumers and business
may have greater confidence in the banking system. This is due to the

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reduction of moral hazard. If the central bank cannot act as a lender of last
resort, banks would have to take the right precautions to manage solvency
and liquidity problems better.
Ultimately, Calvo (2001) explains that a lender of last resort does not only
have to be able to print money, and that in developed countries the central
bank acts as a lender of last resort by issuing bonds and public debt.
Therefore, although harder for developing countries, their central bank can
also act as a lender of last resort without printing money, by carefully planning
lender of last resort activities, such as negotiating credit lines and stocking on
international reserves. Calvo (2001) presents Panama as an example of an
alternative to lender of last resort; he explains that Panama relies on an
international banking system that allows the local branches in Panama offices
to draw liquidity from the head office, resulting in little possibility of solvency
problems.
2.1.3. Losing Independent Monetary Policy
When a country has independent monetary policy, they can control the money
supply, as a result they can impact interest rates and inflation. When a
country dollarizes they cannot affect the money supply anymore, therefore
they lose sovereign monetary policy, and cannot use fiscal policy to stabilize
negative external or domestic shocks Quispe-Agnoli (2002). However, when a
country is under a fixed exchange rate regime, they do not have independent
monetary policy either, therefore to change from this regimen to dollarization
would have no cost, Chang (2000).
According to Hinds (1999) the fact that developing countries lose monetary
policy might be a benefit rather than a cost because developing countries

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don’t have a good record managing the money supply. Based on this, he
believes if they cannot affect the money supply it will create confidence to
investors. Chang (2000) shows that developing countries under a floating
exchange rate regime grew, on average, half a percentage point more than a
typical country; while countries under a fixed exchange rate regime grew at
the same pace on average, than normal a country. The cost has been
consistently higher and more variable inflation. In order to see the real costs
of dollarization, according to Chang (2000) we must balance the value of
stable price levels under dollarization against the better behavior of output
and employment in flexible exchange rates.
2.2.Benefits
2.2.1. Eliminating Currency Risk
There are several benefits of why a country would want to dollarize, one of
them is that it will lower the risk premium by lowering the exchange rate risk.
When investors or business trade in other countries they need to use the local
currency. When they are dealing with a non-stable currency, they take the
risk that the currency will devaluate which leaves them exposed to losing a lot
of money. Thus, investors often hedge, but hedging foreign exchange risk is
timely and costly and this makes contracts in other currencies less attractive
than similar contracts in strong currencies such as the U.S dollar. When a
country dollarizes, the exchange rate risk is eliminated and investors and
businesses can save the costs of hedging this risk. Business are also able to
operate thinking on a long-term, because they are sure that the exchange rate
will not change, and banks are able to offer them long-term loans. According
to Chang (2000) sovereign risk might also be reduced. This is because the

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government and domestic residents often have liabilities in foreign currency,
but their revenues depend on the value of their domestic currency, if the
domestic currency devaluates, the relative value of the liabilities increases
and this causes bankruptcies, this is avoided when a country dollarizes.
However, as explained by Parodi (2001) while dollarization might lower
country risk, it is not necessarily the case because when the country faces
fiscal problems or the banking system shows unhealthy signs investors might
decide to take their money out of the country, which might lead to a banking
crisis.
2.2.2. Lowering the Cost of Credit
In developing countries, most of the time small enterprises and individuals are
not able to access credit denominated in U.S dollars; therefore, they are stuck
with borrowing in domestic currency that carry a higher interest rate, the
higher interest rate is a result of the risk that the currency will devaluate. If a
country dollarizes, there is no option of borrowing in domestic currency and all
the loans would be made in U.S dollars, which usually carry a much lower
interest rate, small companies and individuals are greatly benefited by this.
According to hinds (1999) In Latin America there is not a lot of access to long
term loans because of the fear of currency devaluation, by eliminating this risk
people would be able to access long-term loans with lower interest rates.
According to Quispe-Agnoli (2002), since by dollarizing the currency risk is
eliminated, public debt service will also decline, and the private sector will see
an increase in capital flows.

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2.2.3. Other Benefits of Dollarization
Another added benefit of dollarization is that it will bring greater fiscal
discipline, since the Central Bank cannot act as a lender of last resort
anymore. The government would be more careful to avoid fiscal deficit,
because they would only be able to pay by raising taxes and external lines of
credit and not by printing money. Quispe-Agnoli (2002) argues that by giving
up monetary policy, fiscal discipline will be encouraged, but this will come with
the cost of impeding them to use any fiscal policy to counteract negative
external or domestic shocks. Calvo (2001) explains that for emerging markets,
dollarization might be a good option because most lack credibility; therefore,
they often suffer high interest rates and volatility, and they cannot enjoy the
benefits of a floating exchange rate regimen.
The U.S is one of Latin America’s biggest trading partners; a huge percentage
of their imports and exports come and go from the United States. By
dollarizing, Latin American economies can reduce the transaction costs of
currency exchanges, which would encourage trade. Dollarization would also
increase the competition in the local financial markets because international
banks would be encouraged to enter the local markets. As Quispe-Agnoli
(2002) explains, reversing dollarization would be very costly, which makes
investors believe in the long-term plans of fiscal stability.
According to Quispe-Agnoli and Whisler (2006), banks would benefit from the
lower inflation and price stability that dollarization brings, which would
increase the confidence and foster stability in banks. This, in turn, would
increase bank deposits and loans, which creates a more stable banking
system.

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Hinds (1999) explain that dollarization would also bring social benefits; the
lower interest rates would increase the access to credit to the population.
Dollarization would also protect the pension funds against inflation and
devaluation.

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3. Findings for Ecuador and El Salvador
Ecuador and El Salvador have been dollarized for fourteen and thirteen years.
It is important to see the effects that dollarization has had on their Economies.
Dollarization promised to lower interest rates and reduce Inflation, thus it is
important to observe if these theoretical arguments have materialized.
Another important factor to look into is how GDP growth has developed after
dollarization, to prove if there has been greater economic growth.
3.1.GDP Growth
3.1.1. Ecuador
Figure 1: GDP Growth Rate

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Table 1: Ecuador's GDP Growth Rate Before
Dollarization
Year GDP (%)
1990 3.0
1991 5.1
1992 3.6
1993 2.0
1994 4.3
1995 2.3
1996 1.7
1997 4.3
1998 3.3
1999 -4.7
Average 2.5
Table 2: Ecuador's GDP Growth Rate After
Dollarization
Year GDP (%)
2000 1.1
2001 4.0
2002 4.1
2003 2.7
2004 8.2
2005 5.3
2006 4.4
2007 2.2
2008 6.4
2009 0.6
2010 3.5
2011 7.8
2012 5.1
2013 4.2
Average 4.3
Table 1 shows that between the years 1990 and 1999 before dollarization,
Ecuador had an average growth of 2.5%, while table 2 shows that the years
following dollarization, from 2000 to 2013 Ecuador grew an average of 4.3%,
almost double the average than before dollarization. In 2004, Ecuador had a
large growth of 8.3% this was due to the new oil pipeline that more than
doubled Ecuador’s oil output. Yet in 2009, Ecuador grew only 0.6% because
the world was going through a financial crisis. Many nations around the world
went through a recession during 2009; however, Ecuador managed to grow
slightly. We can see in figure 1 the positive effect that dollarization had on
Ecuador’s growth. Therefore, Dollarization, together with the introduction of
the economic transformation law, helped Ecuador grow and stabled the

20
economy, which helped with the recovery of the crisis explained in the section
1.3.
3.1.2. El Salvador
Table 3: El Salvador's GDP Growth Rate Before
Dollarization
Year GDP (%)
1990 4.8
1991 3.6
1992 7.5
1993 7.4
1994 6.1
1995 6.4
1996 1.7
1997 4.2
1998 3.7
1999 3.4
2000 2.2
Average 4.6
Table 4: El Salvador's GDP Growth Rate After
Dollarization
Year GDP (%)
2001 1.7
2002 2.3
2003 2.3
2004 1.9
2005 3.6
2006 3.9
2007 3.8
2008 1.3
2009 -3.1
2010 1.4
2011 2.2
2012 1.9
2013 1.6
Average 1.9
Table 3 and table 4 shows that El Salvador had a bigger GDP growth before
dollarization. From 1990 to 2000, El Salvador grew an average of 4.6 % while
between 2001 and 2013 El Salvador only grew and average of 1.9%. From
figure 1, we can see that just after dollarization GDP growth plummeted
because El Salvador faced two earthquakes that damaged infrastructure
together with an increase in oil prices as well as a decline in international
coffee prices (Quispe-Agnoli & Whisler, 2006). Furthermore, in 2009 we can
see that the economy contracted by 3.1 %; this can be attributed to the
financial crisis of 2008. Nevertheless, the next year, the economy saw a slight
growth of 1.4%. In consequent years there has been a sluggish growth in the

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economy. El Salvador has not had fiscal discipline, and it has had a fiscal
deficit of 4% of the GDP for the last four years. The public debt has increased
as well, from 49.5 % of the GDP in 2009 to 60 % of the GDP in 20143.
Therefore, we can see that dollarization has not been enough to encourage
economic growth in El Salvador.
3.1.3. Inflation Rate
One of the theoretical benefits that eliminating domestic currency is supposed
to bring is a lower inflation rate, closer to the inflation rate in the anchor
country. Consequently, lower inflation would bring price stability and
businesses and consumers would benefit by being able to make long-term
plans.
Figure 2: Inflation Rate
3 Data found in the newspaper El Diario de hoy, titled “Deuda pública de El Salvador
ya supera los $15,100 millones.” Found at :
http://www.elsalvador.com/mwedh/nota/nota_completa.asp?idCat=47654&idArt=874
7111

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Table 5: Inflation Rate Before and After Dollarization
Year Ecuador EL Salvador United States
1990 48.5 28.3 5.419
1991 48.8 14.4 4.216
1992 54.3 11.2 3.042
1993 45.0 22.6 2.97
1994 27.4 7.2 2.596
1995 22.9 9.7 2.805
1996 24.4 9.8 2.937
1997 30.6 4.4 2.338
1998 36.1 2.6 1.547
1999 52.2 0.5 2.193
2000 96.1 2.3 3.367
2001 37.7 3.7 2.817
2002 12.6 1.9 1.596
2003 7.9 2.1 2.298
2004 2.8 4.5 2.668
2005 2.1 4.7 3.366
2006 3.3 4.0 3.222
2007 2.3 4.6 2.871
2008 8.4 7.3 3.815
2009 5.2 0.5 -0.32
2010 3.6 1.2 1.638
2011 4.5 5.1 3.142
2012 5.1 1.7 2.075
2013 2.7 0.8 1.464
Average inflation
before dollarization 39.0 10.3
Average Inflation
After dollarization 13.9 3.2
As shown in figure 2, inflation in Ecuador was very high before dollarization,
from 1990 to 1999, inflation averaged 39%, while in the years after
dollarization from 2000 to 2013 it decreased to an average of 13.9%. In 1999,
before dollarization, Ecuador’s inflation rose rapidly, Ecuador was going
through recession. According to Parodi (2001), in August 1999, Ecuador was
the first country to default on Brady-bond debt; bank deposits were frozen and

23
the sucre had fallen 80 percent over the past 16 months. After dollarization,
the economy recovered at a slow pace and inflation rates slowly declined,
reaching 7.9 % in 2003, a big decrease from the 96.1 % in 2000. In 2013,
inflation managed to reach low levels at 2.7%, close to the inflation rate in the
United States. Hence, dollarization did bring low inflation rates and fostered
stability.
In the case of El Salvador, table 5 shows that inflation before dollarization
averaged 10.3%, from 1990 to 2000, while in the years following dollarization
between 2001 and 2013, it averaged 3.2%. Although El Salvador’s inflation
was never as high as Ecuador’s, dollarization still managed to lower the
inflation, and it reached levels comparable to United States’ levels.
As we can see from the figure 2, after dollarization inflation lowered both in
Ecuador and in El Salvador, and from 2004 they both had levels close to The
U.S inflation rate. Thus, dollarization does bring low inflation and as a result,
both Ecuador and El Salvador were able to foster price stability.
3.1.4. Interest Rates
Figure 3: Lending Interest Rate

24
Table 6: Lending Interest Rates
Year Ecuador (%) El Salvador (%)
United States
(%)
1990 37.5 21.17 10.0
1991 46.7 19.67 8.5
1992 60.2 16.43 6.3
1993 47.8 19.42 6.0
1994 44.0 19.03 7.1
1995 55.7 19.08 8.8
1996 54.5 18.57 8.3
1997 43.0 16.05 8.4
1998 49.5 14.98 8.4
1999 17.4 15.46 8.0
2000 17.1 10.74 9.2
2001 16.2 9.60 6.9
2002 15.8 7.14 4.7
2003 13.6 6.56 4.1
2004 10.0 6.30 4.3
2005 9.6 6.87 6.2
2006 9.8 7.53 8.0
2007 14.9 7.81 8.1
2008 9.1 7.87 5.1
2009 9.1 9.32 3.3
2010 8.6 7.62 3.3
2011 8.4 5.99 3.3
2012 8.2 5.69 3.3
2013 8.2 6.09 3.3
Average Before
Dollarization
45.6 17.33
Average After
Dollarization
11.3 7.26
Ecuador benefited from dollarization in the form of lower interest rates, as
shown in figure 3. Interest rates reduce steeply in the years following
dollarization. The lending interest rate averaged 45.6% from 1990 to 1999,
while after dollarization the average was 11.6% from 2000 to 2012, thus,
allowing people and businesses to get loans at a lower cost. The decreased
cost of borrowing enables businesses to invest and grow, and allows more
people to access the housing market.

25
Even though El Salvador’s interest rates were not as high as Ecuador’s, they
still decreased after dollarization. The lending interest rate for El Salvador for
the years 1990 to 2000 averaged 17.33%, while after dollarization it averaged
7.26% from the years 2001 to 2013.
Figure 3 shows that El Salvador’s interest rates have always been closer to
the United States’ interest rates, becoming even closer after dollarization. For
Ecuador, it took some adjustment time, however from 2004, the lending
interest rate decreased even further, and in 2005 it reached one digit at 9.6 %.
As a result of the lower interest rates, both in El Salvador and Ecuador,
people and businesses profit by being able to access credits at lower costs.
The decreased cost of borrowing enables businesses to invest and grow, and
allows more people to access the housing market.
As we can see in both countries, dollarization was able to lower interest rates
and inflation, which dropped to levels comparable to the United States.
Nevertheless, GDP didn’t see much growth in the case of El Salvador,
suggesting that dollarization alone does not bring economic growth. In the
case of Ecuador, GDP grew faster after dollarization, which suggests that it
had a positive effect on the growth.

26
4. Comparison of Ecuador and El Salvador with their Neighbor
Countries
After studying the development of some economic indicators of Ecuador and
El Salvador after dollarization, it is also important to see how these two
countries compare to their neighbor countries. Ecuador and El Salvador are
not geographically close, and they have different characteristics in terms of
what they export and import. Consequently, it is important to compare them to
their neighbor countries, with which the share similar characteristics.
4.1.Comparison of Ecuador’s, Peru’s, Colombia’s and Chile’s GDP Growth
Rate, Inflation rates and Interest Rates.
4.1.1. GDP growth rate of Ecuador compared to the GDP growth rate of
Colombia, Peru and Chile.
Figure 4: GDP Growth

27
Table 7: GDP Growth before dollarization in Ecuador
Year Ecuador Colombia Peru Chile
1990 3.0 6.0 -5.1 3.7
1991 5.1 2.3 2.2 8.0
1992 3.6 5.0 -0.4 12.3
1993 2.0 2.4 4.8 7.0
1994 4.3 5.8 12.8 5.7
1995 2.3 5.2 8.6 10.6
1996 1.7 2.1 2.5 7.4
1997 4.3 3.4 6.9 6.6
1998 3.3 0.6 -0.7 3.2
1999 -4.7 -4.2 0.9 -0.8
Average 2.48 2.86 3.24 6.38
Table 8: GDP Growth after dollarization in Ecuador
Year Ecuador Colombia Peru Chile
2000 1.1 4.4 3.0 4.5
2001 4.0 1.7 0.2 3.3
2002 4.1 2.5 5.0 2.2
2003 2.7 3.9 4.0 4.0
2004 8.2 5.3 5.0 6.0
2005 5.3 4.7 6.8 5.6
2006 4.4 6.7 7.7 4.4
2007 2.2 6.9 8.9 5.2
2008 6.4 3.5 9.8 3.3
2009 0.6 1.7 0.9 -1.0
2010 3.5 4.0 8.8 5.8
2011 7.8 6.6 6.9 5.9
2012 5.1 4.2 6.3 5.6
2013 4.2 4.3 5.0 4.1
Average 4.3 4.3 5.6 4.2
Table 7 shows that, before dollarization, from the years 1990 to 1999, Ecuador
(2.48%) grew on average less than Colombia (2.86%), Peru (3.24%), and
Chile (6.38%). Whereas, after dollarization (Table 8), Ecuador (4.3%)
managed to grow on average at a similar rate with Colombia (4.3%) and Chile
(4.2%), this is a big advantage that Ecuador has obtained from dollarizing.

28
4.1.2. Inflation rate of Ecuador compared to the inflation rate of Colombia,
Peru, and Chile.
Table 9: Inflation Rate Before Dollarization in Ecuador
Year
Ecuador
(%)
Colombia
(%)
Peru (%)
Chile
(%)
1990 48.5 29.1 7481.7 25.9
1991 48.8 30.4 409.5 22.0
1992 54.3 27.0 73.5 15.5
1993 45.0 22.4 48.6 12.7
1994 27.4 22.8 23.7 11.5
1995 22.9 20.9 11.1 8.2
1996 24.4 20.8 11.5 7.4
1997 30.6 18.5 8.6 6.1
1998 36.1 18.7 7.2 5.1
1999 52.2 10.9 3.5 3.3
Average 39.0 22.2 807.9 11.8

29
Table 10: Inflation Rate After Dollarization in Ecuador
Year
Ecuador
(%)
Colombia
(%)
Peru (%) Chile (%)
2000 96.1 9.2 3.8 3.8
2001 37.7 8.0 2.0 3.6
2002 12.5 6.4 0.2 2.5
2003 7.9 7.1 2.3 2.8
2004 2.7 5.9 3.7 1.1
2005 2.4 5.0 1.6 3.0
2006 3.0 4.3 2.0 3.4
2007 2.3 5.5 1.8 4.4
2008 8.4 7.0 5.8 8.7
2009 5.2 4.2 2.9 1.6
2010 3.6 2.3 1.5 1.4
2011 4.5 3.4 3.4 3.3
2012 5.1 3.2 3.7 3.0
2013 2.7 2.2 2.8 1.8
Average 13.9 5.3 2.7 3.2
Ecuador suffered higher inflation than Chile and Colombia before it dollarized.
Inflation was exceedingly high because of the banking crisis. Peru suffered
hyperinflation in the 90s, while Colombia and Chile’s inflation averaged 22.2%
and 11.8% respectively, much lower than Ecuador’s 39% average. After
Ecuador dollarized, it took a few years for inflation to go down, but by 2004,
inflation rose only 2.7%. In 2013, inflation in all four countries remained low,
Ecuador 2.7%, Colombia 2.2%, Peru 2.8%, and Chile 1.8%.

30
4.1.3. Lending interest rate of Ecuador compared to the lending interest
rate of Colombia, Peru, and Chile.
Figure 6: Lending Interest Rates
Table 11: Lending Interest Rate Before Dollarization in Ecuador
Year
Ecuador
(%)
Colombia
(%)
Peru (%)
Chile
(%)
1990 37.5 45.2 4774.5 48.9
1991 46.7 47.1 751.5 28.6
1992 60.2 37.3 173.8 24.0
1993 47.8 35.8 94.2 24.3
1994 44.0 40.5 55.3 20.3
1995 55.7 42.7 36.2 18.2
1996 54.5 42.0 31.5 17.4
1997 43.0 34.2 30.9 15.7
1998 49.5 42.2 32.6 20.2
1999 17.4 25.8 35.1 12.6
Average 45.6 39.3 601.6 23.0

31
Table 12: Lending Interest Rate After Dollarization in Ecuador
Year
Ecuador
(%)
Colombia
(%)
Peru (%)
Chile
(%)
2000 17.1 18.8 30.0 14.8
2001 16.2 20.7 25.0 11.9
2002 15.8 16.3 20.8 7.8
2003 13.6 15.2 21.0 6.2
2004 10.0 15.1 24.7 5.1
2005 9.6 14.6 25.5 6.7
2006 9.8 12.9 23.9 8.0
2007 14.9 15.4 22.9 8.7
2008 9.1 17.2 23.7 13.3
2009 9.1 13.0 21.0 7.3
2010 8.6 9.4 19.0 4.8
2011 8.4 11.2 18.7 9.0
2012 8.2 12.6 19.2 10.1
Average 11.6 14.8 22.7 8.7
As shown in table 11, lending interest rates before dollarization were higher in
Ecuador than in Colombia and Chile, but they were much higher in Peru.
Table 12 shows that after dollarization, Ecuador’s lending interest rates
lowered to an average of 11.6%, lower than the average lending interest rate
in Colombia 14.8 and Peru 22.7%, but higher than the average in Chile 8.7%.
Chile managed to lower its lending interest rate more than Ecuador without
dollarizing, however Chile has a strong economy, and according to the World
Bank, is a high-income country and it’s close to becoming a developed
country. Colombia and Peru lowered their interest rates substantially without
dollarization, however not as low as Ecuador did. Therefore, dollarization was
very helpful for Ecuador to lower its interest rates, which promoted growth
because people can access long-term loans at a low cost.

32
4.2.Comparison of El Salvador’s, Honduras’, Guatemala’s and Nicaragua’s
GDP Growth Rate, Inflation rates, and Interest Rates.
4.2.1. GDP Growth Rate of El Salvador compared to the GDP Growth Rate
of Honduras, Guatemala, and Nicaragua
Figure 7: GDP Growth
Table 13: GDP Growth Before Dollarization in El Salvador
Year
El Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
1990 4.8 0.1 3.1 -0.1
1991 3.6 3.3 3.7 -0.2
1992 7.5 5.6 4.8 0.4
1993 7.4 6.2 3.9 -0.4
1994 6.1 -1.3 4.0 3.3
1995 6.4 4.1 4.9 5.9
1996 1.7 3.6 3.0 6.3
1997 4.2 5.0 4.4 4.0
1998 3.7 2.9 5.0 3.7
1999 3.4 -1.9 3.8 7.0
2000 2.2 5.7 3.6 4.1
Average 4.6 3.0 4.0 3.1

33
Table 14: GDP Growth After Dollarization in El Salvador
Year
El Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
2001 1.7 2.7 2.3 3.0
2002 2.3 3.8 3.9 0.8
2003 2.3 4.5 2.5 2.5
2004 1.9 6.2 3.2 5.3
2005 3.6 6.1 3.3 4.3
2006 3.9 6.6 5.4 4.2
2007 3.8 6.2 6.3 5.0
2008 1.3 4.2 3.3 4.0
2009 -3.1 -2.4 0.5 -2.2
2010 1.4 3.7 2.9 3.6
2011 2.2 3.8 4.2 5.4
2012 1.9 3.9 3.0 5.2
2013 1.6 2.5 3.3 4.6
Average 1.9 4.0 3.4 3.5
As shown in figure 7, El Salvador’s GDP growth rate before dollarization was
more competitive, surpassing Honduras, and in some periods Nicaragua,
whereas after dollarization, El Salvador’s GDP was the lowest between all
Honduras, Nicaragua, and Guatemala. El Salvador’s economy was the most
affected during the financial Crisis of 2008, most likely because its economy
has close ties to The United States economy, which suffered greatly during
the crisis. El Salvador’s economy depends greatly on The United States; more
than one million Salvadorans live in The U.S, who send each month
remittances to their family members. According to the CIA world factbook
remittances from the Unites States to El Salvador Accounted for 17% of the
GDP in 2013. During the 2008 financial crisis, the lack of jobs in the United
States made it hard for Salvadorans living there to send money back to El
Salvador, thus El Salvador’s GDP decreased by 3.1 percent, and was the
most affected in the Region. Another reason why El Salvador’s GDP did not

34
have much growth, is the lack of for FDI, and lack of encouragement from the
government to attract it.
4.2.2. Inflation Rate of El Salvador compared to the Inflation Rate of
Honduras, Guatemala, and Nicaragua
Table 15: Inflation Rate Before Dollarization in El Salvador
Year
El
Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
1990 28.3 23.3 41.2 -
1991 14.4 34.0 33.2 -
1992 11.2 8.8 10.0 -
1993 22.6 10.7 11.8 -
1994 7.2 21.7 10.9 -
1995 9.7 29.5 8.4 -
1996 9.8 23.8 11.1 -
1997 4.4 20.2 9.2 -
1998 2.6 13.7 6.6 -
1999 0.5 11.7 5.2 -
2000 2.3 11.0 6.0 -
Average 10.3 18.9 14.0 -

35
Table 16: Inflation Rate After Dollarization in El Salvador
Year
El
Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
2001 3.7 9.7 7.3 6.0
2002 1.9 7.7 8.1 3.8
2003 2.1 7.7 5.6 5.3
2004 4.5 8.1 7.6 8.5
2005 4.7 8.8 9.1 9.6
2006 4.0 5.6 6.6 9.1
2007 4.6 6.9 6.8 11.1
2008 7.3 11.4 11.4 19.8
2009 0.5 5.5 1.9 3.7
2010 1.2 4.7 3.9 5.5
2011 5.1 6.8 6.2 8.1
2012 1.7 5.2 3.8 7.2
Average 3.4 7.3 6.5 8.1
Figure 8 shows that since 1994, even before dollarization, inflation rate has
been lower in El Salvador, than in Honduras, Guatemala, and Nicaragua.
Since dollarization, El Salvador has been able to lower even more its inflation
rate well below than in Honduras, Guatemala and Nicaragua. El Salvador’s
inflation for 2012 was 1.7%; the country that follows is Guatemala with 3.8 %,
more than double the inflation in El Salvador. Low inflation is one of the
benefits received from dollarization. We can see that El Salvador has
benefited from it. Subsequently, prices and wages have been able to remain
stable and people’s purchasing power has not had a big decline.

36
4.2.3. Lending Interest Rate of El Salvador compared to the Lending
Interest Rate of Honduras, Guatemala, and Nicaragua.
Figure 9: Lending Interest Rate
Table 17: Lending Interest Rate Before Dollarization in El Salvador
Year
El
Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
1990 21.2 17.1 23.3 22.0
1991 19.7 21.9 34.1 17.9
1992 16.4 21.7 19.5 19.3
1993 19.4 22.1 24.7 20.2
1994 19.0 24.7 22.9 20.1
1995 19.1 27.0 21.2 19.9
1996 18.6 29.7 22.7 20.7
1997 16.1 32.1 18.6 21.0
1998 15.0 30.7 16.6 21.6
1999 15.5 30.2 19.5 17.6
2000 14.0 26.8 20.9 18.1
Average 17.6 25.8 22.2 19.9

37
Table 18: Lending Interest Rate After Dollarization in El Salvador
Lending Interest Rate After Dollarization in El Salvador
Year
El
Salvador
(%)
Honduras
(%)
Guatemala
(%)
Nicaragua
(%)
2001 10.7 23.8 19.0 18.6
2002 9.6 22.7 16.9 18.3
2003 7.1 20.8 15.0 15.5
2004 6.6 19.9 13.8 13.5
2005 6.3 18.8 13.0 12.1
2006 6.5 17.4 12.8 11.6
2007 7.8 16.6 12.8 13.0
2008 7.9 17.9 13.4 13.2
2009 9.3 19.4 13.8 14.0
2010 7.6 18.9 13.3 13.3
2011 6.0 18.6 13.4 10.5
2012 5.7 18.5 13.5 12.0
Average 7.6 19.4 14.2 13.8
As shown in figure 9, lending interest rates have been lower in El Salvador
than in Honduras, Guatemala, and Nicaragua. However, after dollarization,
they dropped even further from 14 % in 2000, to 10.7 % in 2001, and they
have steadily decreased. El Salvador’s neighbors have kept higher interest
rates with Nicaragua being the second averaging 13.8 from 2001 to 2012;
almost double the average in El Salvador for the same period 7.6%. This is
good for the Salvadorian Economy because the cost of doing business and
investing remains low. A low interest rate is benefit El Salvador has been able
to obtain from dollarization, which other countries in the region, like Honduras,
Nicaragua, and Guatemala, don’t have.

38
5. Conclusion
This thesis has shown the basic concept of dollarization, and it has
highlighted what Ecuador and El Salvador went through that made them take
the decision to dollarize. As presented before Ecuador was under a banking
crisis and had serious economic problems, while El Salvador’s economy was
stable and they had maintained a fixed exchange rate throughout most of the
90s. Ecuador’s decision was made to solve a collapsing banking system
whereas El Salvador’s was to encourage a better more stable economy.
We have seen that dollarizing brings both benefits and costs, and we have
also seen that some of the costs can also be benefits like losing the lender of
last resort might make banks manage their policies better, and losing
independent monetary policy stops banks from being able to print money,
therefore reducing the possibility for a country to suffer high inflation.
We have seen dollarization eliminates currency risk, which benefits
investment; however, country risk is not necessarily lowered and the
dollarized country needs to show signs of a healthy economy in order to
attract investment. Lower cost of credit is one of the most beneficial things
dollarization brings because it allows more people the chance to own a house.
It also encourages more people to start new businesses, while benefiting
existing ones. Businesses are able to expand at a low cost and with longer
maturity loans than they could get prior to dollarization. Dollarization has
facilitated trade between the US and Ecuador & El Salvador. El Salvador
especially benefits from this because they have a free trade agreement
(CAFTA) with the United States since 2003.

39
In the second part of this study, we have seen the behavior of some economic
indicators after dollarization. After dollarization, inflation decreased, both in
Ecuador and El Salvador, to levels comparable to the United States’, Ecuador
has specially benefited from this because of the high inflation it was suffering
before dollarization. Interest rates have decreased in Ecuador and El
Salvador as well, and are currently close to the rates in The U.S. For the GDP,
we can see mixed results. In Ecuador GDP has grown at a higher rate than
before dollarization. However, El Salvador has seen lower growth, which
suggests that dollarization alone does not lead to higher growth. Although
dollarization promotes growth by lowering interest rates and lowering inflation,
the country ultimately needs to create the according policies to promote
growth. The country needs to have fiscal discipline, which El Salvador has not
had.
When comparing Ecuador to its neighbors Colombia, Peru, and Chile, we
have seen that GDP growth after dollarization has increased at around the
same rate than its neighbors, whereas before dollarization growth was lower
in Ecuador than its neighbors.
In the case of Inflation, Ecuador has managed to catch up with the inflation
levels in its neighbor countries. For lending interest rates, Ecuador’s have
been lower than Colombia’s and Peru’s and has had similar levels as Chile’s,
which is strong stable country, after dollarization.
In El Salvador, Dollarization has kept inflation at a much lower rate than its
neighbors Honduras, Guatemala, and Nicaragua. Interest rates in El Salvador
have been lower than its neighbors since before dollarization; however, after
dollarization the difference is more pronounced, making El Salvador’s interest

40
rates one of the lowest in the region. Nonetheless, El Salvador has not seen
much growth, and when compared to its neighbors it falls far behind.
The main lesson that we can learn from dollarization is that it is an effective
way of lowering interest rates and inflation rates, but in order for GDP to grow
each country needs to create policies that promote growth.

41
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Calvo, G. A. (2001). Capital Markets and the Exchange Rate, with Special
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Banking Committee.

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Hinds, M. (2004). Is Dollarization a Worthwhile Option for Developing
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