Abstract

IBARRA, David; MORENO-BRID, Juan Carlos; GARCIA, Jesús  and  HERNANDEZ, René. Dollarization in El Salvador: The Implications, Advantages and Risks. Inv. Econ [online]. 2004, vol.63, n.248, pp.71-93. ISSN 0185-1667.

At the end of the year 2000, the Salvadorian government made a unilateral decision to “dollarize” their economy. The fundamental step was taken in November of that year with the congressional approval of the Monetary Integration Act (Ley de Integración Monetaria) which came into effect on January 1st of 2001. The new law radically changed the legal framework of the Salvadorian monetary and financial system by allowing complete use of the dollar for all commercial and financial transactions. According to Salvadorian authorities, such a radical reform would bring about important economic benefits to the country, especially in the long run. The central argument for monetary integration was that it would lower inflation to a point convergent to that of the United States. Domestic interest rate volatility would be greatly reduced because exchange rate risk would be eliminated. Furthermore, this was also expected to strengthen financial markets and increase financial depth. This would, most importantly, increase the supply of long-term credit available for investment purposes. Since it has only been a short while since the enactment of the Monetary Integration Act and, in principle, the benefits of dollarization should materialize in the medium and the long run; it would be premature to try to form a comprehensive evaluation of the effects of integration on the Salvadorian economy. Therefore, this paper will be centered on reviewing some of the main implications of dollarization, identifying its advantages and risks as well as on examining other elements of significant relevance.

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