Determining which monetary policy to implement in a country is of utmost importance for the well-being of the economy. This thesis examines dollarization, when a country chooses to use another major currency as a legal tender, while the central bank stops issuing local currency. Dollarization is a monetary policy that only a few countries have taken, and the majority of them are small developing countries, which benefit from the use of a stable currency.
The focus of this thesis is to study the cases of Ecuador and El Salvador, which are two of the biggest economies that have officially dollarized. An analysis of the costs of dollarizing such as losing independent monetary policy, losing seigniorage revenue, and losing the lender of last resort is weighted against the benefits of reducing the currency risk, lowering the cost of credit, and keeping prices stable. Next, findings on how dollarization affected GDP growth, inflation rate, and interest rates in these two countries are shown. The results show that, as expected, dollarization managed to lower interest rates as well as inflation rate, however, for the GDP growth Ecuador’s GDP grew at a faster pace after dollarization, while El Salvador’s decreased.

ABSTRACT 2
1. INTRODUCTION 5
1.1. DOLLARIZATION 6
1.2. REQUIREMENTS FOR DOLLARIZING 8
1.3. ECUADOR 8
1.4. EL SALVADOR 9
2. COSTS AND BENEFITS OF DOLLARIZATION 11
2.1. COSTS 11
2.1.1. Losing Seigniorage Revenue 11
2.1.2. Losing the Lender of Last Resort 12
2.1.3. Losing Independent Monetary Policy 13
2.2. BENEFITS 14
2.2.1. Eliminating Currency Risk 14
2.2.2. Lowering the Cost of Credit 15
2.2.3. Other Benefits of Dollarization 16
3. FINDINGS FOR ECUADOR AND EL SALVADOR 18
3.1. GDP GROWTH 18
3.1.1. Ecuador 18
3.1.2. El Salvador 20
3.1.3. Inflation Rate 21
3.1.4. Interest Rates 23
4. COMPARISON OF ECUADOR AND EL SALVADOR WITH THEIR NEIGHBOR COUNTRIES 26
4.1. COMPARISON OF ECUADOR’S, PERU’S, COLOMBIA’S AND CHILE’S GDP GROWTH RATE, INFLATION RATES AND INTEREST RATES. 26
4.1.1. GDP growth rate of Ecuador compared to the GDP growth rate of Colombia, Peru and Chile. 26
4.1.2. Inflation rate of Ecuador compared to the inflation rate of Colombia, Peru, and Chile. 28
4.1.3. Lending interest rate of Ecuador compared to the lending interest rate of Colombia, Peru, and Chile. 30
4.2. COMPARISON OF EL SALVADOR’S, HONDURAS’, GUATEMALA’S AND NICARAGUA’S GDP GROWTH RATE, INFLATION RATES, AND INTEREST RATES. 32
4.2.1. GDP Growth Rate of El Salvador compared to the GDP Growth Rate of Honduras, Guatemala, and Nicaragua 32
4.2.2. Inflation Rate of El Salvador compared to the Inflation Rate of Honduras, Guatemala, and Nicaragua 34
4.2.3. Lending Interest Rate of El Salvador compared to the Lending Interest Rate of Honduras, Guatemala, and Nicaragua. 36
5. CONCLUSION 38
REFERENCES 41

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