Academic journal article Journal of Economic Issues

Dollarization in Latin America: Wave of the Future or Flight to the Past?

Academic journal article Journal of Economic Issues

Dollarization in Latin America: Wave of the Future or Flight to the Past?

Article excerpt

Latin American economic policy during the 1990s was guided by the "Washington consensus," which embodied the orthodox model's espousal of free trade and economic liberalization (Williamson 1990). Macroeconomic performance improved over the lost decade of the 1980s, aided by new capital inflows. However, Nancy Birdsall and Augusto de la Torre (2001, 6) noted that "in economic growth, poverty reduction, income distribution, and social conditions the results were discouraging." This outcome is no surprise to institutionalists and those not committed to the orthodox model (Lichtenstein 2000; Schneider 1999; Went 2000).

The Washington consensus left the issue of exchange rate regime open, suggesting "that achieving a 'competitive' exchange rate is more important than how the rate is determined" (Williamson 1990, 13-14), although floating rates had "some support in Washington ... as the more important [principle]"(13). However, David Felix (1997/8) documented increased exchange rate volatility and its detrimental effect on trade, investment, financial stability, and macroeconomic policy in Latin America. Taking a Keynesian perspective, he pointed to capital mobility after the demise of Bretton Woods as the main contributor to this discouraging performance.

Orthodox economists placed the onus on bad domestic policy or faulty choice of exchange rate regime. After the collapse of their pegged rates in the Asian miracle economies, orthodoxy demanded that countries operate in a bipolar world, either floating their currencies or adopting a hard peg such as dollarization (Fischer 2001a). In addition, the successful European transition to the euro, active research on optimal currency areas (Panizza, Stein, and Talvi 2003; Courchene and Harris 2000), and widespread use of the dollar in Latin America combined to suggest dollarization as a solution to the problems noted by Felix. Ecuador undertook official dollarization in 2000 when it destroyed its own currency, the sucre, and adopted the dollar. El Salvador converted all financial instruments to dollars, and Guatemala now allows transactions to be carried out in any currency. Both assumed that the dollar would soon displace their domestic currencies. This experience suggests that dollarization may become progressively easier for other countries. Indeed, there are numerous predictions of a completely dollarized Western Hemisphere (Schuldt 2003; Trejos 1999; "La Dolarizacion Sera. Una Realidad en la Proxima Decada," by Eduardo Tuculet, Tiempos del Mundo, July 19, 2001, B24-27).

Will other countries in the Western Hemisphere implement official dollarization this decade? Could Latin America become an official dollar bloc, with the dollar as the common currency? Alternatively, will dollarization be a momentary phenomenon, whose promise is tarnished by the economic performance of countries that have chosen hard pegs?(1)

In answering these questions, I use the methodology of "pattern models" described in Wilber and Harrison 1978. My model, and point of departure, is to characterize Latin America's international financial relations as a "dollar bloc," an informal but powerful system that binds their currencies to the dominant currency, the dollar (Jameson 1990). This relation, and its supportive institutions such as the International Monetary Fund and the World Bank, dominates Latin America's international economic relations. Whether official dollarization becomes the general choice of exchange rate regime in Latin America in this decade depends on the extent to which dollarization becomes one of the rules of the dollar bloc; it is a question of the institutional evolution of the dollar bloc (Jameson 2001).

I structure the argument as follows. In the first section I place dollarization in historical context, since dollarization is path dependent and the historical experience will affect how the dollar bloc evolves. In the main body of the paper, I examine the most extreme contemporary dollarization program, that of Ecuador. …

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