Dollarization in EcuadorEssay title: Dollarization in Ecuador25 orangesLiquefied Gas20 333 sucre 25 000 sucre$0.81 (dollars)$ 1 dollarIntroduction.or the past century there have been radical changes in economic philosophy, resulting in a debate over which exchange rate is best in a world of high capital mobility and capital flows. This debate has produced revolutionary and innovative answers to the question and with it, substantial sources of disagreement among exchange rate economists. Many economists now recommend that countries give up the idea of intermediate exchange rate models and adopt corner solutions such as free floating exchange rates, and currency boards or dollarization. The latter has become highly popular among emerging economies, principally in Latin America, despite its controversiality.
In the first section of my essay I am going to talk about some of the theory behind the exchange rate and from there decide what is the best choice for EM economies. In the second part, I will analyze some empirical evidence related to currency board and dollarization. In the last and third section of this paper I try to answer the question when is dollarization necessary despite its uncertainty?
1. Which exchange rate is best for EM economies.According to Robert A. Mundell (1960, 1961) “The argument for flexible exchange rates based on national currencies…[works as long as the]…factor [labor and capital] mobility is high internally and low internationally…The flexible exchange system works badly if capital mobility is mobile because the rate of interest has a more direct effect on the balance of payments than on the market to which responds (the goods-and-services market)”. Nowadays, with a globalized world economy with free trade agreements such as NAFTA, CAFTA, MERCOSUR, and regionalized economic unions such as the EU and soon the FTAA, there are no doubts that the degree of capital mobility has become and will only get higher.
Given a globalized world economy, I strongly believe, a flexible exchange rate system is inadequate for small and less diversified emerging market (EM) economies since they are more vulnerable to shocks with respect to more diversified economies. For example, if countries in a region actively participate in the production of an specific final good through the assembly of parts, any shock in the aggregate demand of this good will result in a shock that will affect all economies that participate in the production of this good. Additionally, if these countries’ industries are not very diverse, a small shock will be likely to have a greater effect and remain longer than it would have. Furthermore, EM economies with flexible exchange systems have seen that when shocks occur, the exchange rate system is not able to foresee the incoming crisis as it is expected, and often it worsens the situation before it gets any better (Calvo and Reinhart 2000). Consequently, in agreement with “The Theory of Optimum Currency Areas” (OCA) (Mundell 1961) and because of the high degree of capital mobility combined with a high scale of capital flows, which has been seen to cause high volatility in the exchange rate markets, a flexible exchange rate is undesirable for small and less diversified EM economies. Nevertheless, if these countries find the willingness to devote their energy and resources to low inflation rates and a more credible and stable exchange systems that will facilitate trade which will take them to a faster economic growth path, then the debate suggests adopting “hard-peg” systems such as a currency board or even to dollarization.
The differences between a currency board and dollarization are minimal. A currency board issues local notes and coins that are generally anchored to a more powerful, stable, tradable international currency such as the British pound, American dollar, or Euro. Consequently, the national currency depends on the stability of the foreign pegged-currency, thus resulting in a strictly fixed exchange system. Under a currency board system the country’s monetary policy is determined by supply and demand and not by its central bank policies. The currency board then is unable to adjust the interest rate by setting up a discount rate and it cannot serve as a lender of last resource for the banking system nor for the government. Therefore, the system itself generates awareness
The Currency Board of India is a centralized system, functioning with a range of administrative and institutional functions providing an extensive network of central and executive support. The Board itself has the authority to set interest rates at the time it is satisfied with a specific balance between its primary needs, to promote monetary stability, and to issue currency and other notes that it believes are within the current fixed exchange rate level. The Board operates from the executive head, who has control of the Board’s money management operations and manages a portfolio of foreign currency and foreign exchange notes for government-administered currency in India, foreign real estate and banking services, and to the central bank which manages other services for India. However, this also includes the currency board which is governed by its own head. The head serves to guide the Board in its decision-making work, supervise its decisions, and even provide a financial service to maintain an interest rate stability and provide financing to the other major central banks. The Board operates an integrated system for keeping a close eye on a wide range of matters related to India’s national interest, such as financial stability, domestic growth and consumer spending, growth promotion in the banking sector, economic development, the provision of public services, and economic development and fiscal consolidation. The Board’s decision-making mechanism includes the appointment of an administrative and institutional head and includes the oversight of the Board’s capital structure to facilitate the use of capital for the necessary capital allocation. On a national level, the Board is composed primarily of the Central Governments in central and state in India and the various government sectors including civil sector, state, and financial services, corporate, and industrial relations. The Board is the body’s primary financial officer within the Board as such a head and the Board’s sole financial officer outside government.
In the event of currency crisis, Congress asked the Central bank to support the Bank of India by introducing an indirect banking tax on foreign foreign loans of 50% that could make the interest on any dollar bank out of India (and hence the national currency) more. This would help stabilize the currency for a range of foreign buyers and would reduce the supply of foreign currencies (particularly domestic currency). Currently, the Indian government is heavily invested in the foreign exchange rate system and the interest rate policy of the country has been a core part of the government’s strategy to increase the domestic demand for domestic exchange rate information to increase its ability to stimulate the economy as well as its ability to enhance economic growth. The Central government is willing to share in the economic and fiscal stimulus that the Board has brought into the national interest if necessary in order to stimulate the economy and to generate good economic outcomes.
The Board of Governors of the Reserve Bank of India (RBI) are vested with the political authority to control the monetary policy of India. The Board ensures and serves the independence of its members based on the recommendations of the central bank. The role of each member of the Board is strictly dependent on its members’ judgment of whether the Board is in agreement with one or more of the recommendations of the central bank. The Board regularly informs the Parliament about the results of its decisions as well as