Transcript Salvador
Introduction • On January 1, 2001, El Salvador became the third Latin American country to abandon its own currency in favor of the dollar • Other two Latin American nations to convert to the dollar: • Ecuador in September 2000 and Panama since 1904 Continued… • El Salvador has elected to turn monetary policy over to the U.S. Federal Reserve • Full dollarization was expected to enhance the set of previous structural reforms put in place to support economic stability and thus attract foreign investors Advantages to Dollarization • Ensures relatively low inflation • Low inflation increases the security of private property, which in turn translates into lower interest rates • Consumers can spend more, local businesses are able to invest and obtain financing at more favorable rates Continued… Continued… • Elimination of exchange rate risk, contributing to the decline of the country risk premium and interest rates • As well as the reduction of the inflation rate and inflationary expectations • These outcomes are expected to encourage foreign investment and a stable capital flow Disadvantages to Dollarization • By adopting the dollar as legal tender, El Salvador has effectively lost control of its money supply • Elimination of a true central bank means that El Salvador does not have a lender of last resort • The Salvadorean central banking system is constrained by the amount of dollars it holds in reserve, it cannot print new money to keep up with demand Continued… • Elimination of the governments ability to generate seigniorage • Seigniorage- revenue from issuing domestic money to finance its fiscal deficit • Without this possibility, the dollarizing country must look for alternative revenue sources or reduce government expenditures • Giving up control of its money supply, a full dollarization regime encourages fiscal discipline, enhancing policy credibility, but also constrains the fiscal response to stabilize the economy in difficult times Alternatives to Dollarization • Maintaining a Floating Currency. • Currency with fixed exchange rate. • Coexistence of currencies. Macroeconomic Effect of Dollarization Price Stability. Ease of trade. Closer ties among Central American countries. Microeconomic Effect of Dollarization Pricing of consumer items. Consumer adjustment to currency. Loss of national identity. US/El Salvador Connection How the US recession affects El Salvador. http://www.youtube.com/watch?v=0NR8Lv0p7Uo Thank You Any Questions? Bibliography Bloch S. David, Nelson William Robert, “Dollarization in El Salvador The Costs of Economic Stability”, World Trade Executive Inc, 2003. Quispe-Agnoli Myriam, Whisler Elena, “Official Dollarization and the Banking System in Ecuador and El Salvador”, Economic Review, Federal Reserve Bank of Atlanta, 2006.