Download Salvador

Introduction
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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
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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…
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Elimination of exchange rate risk, contributing to the
decline of the country risk premium and interest rates
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As well as the reduction of the inflation rate and
inflationary expectations
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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…
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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.
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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.