Money, Prices, and Dollarization: Evidence from Ecuador and Peru

Abstract

Recent work on financial openness, currency substitution, and dollarization have brought into question the ability of small economies to have monetary independence or effective monetary control, even with a flexible exchange rate regime. With increasing degrees of openness, currency substitution, and dollarization there is the danger of increasing instability as key variables become either indeterminate or beyond the control of domestic monetary management. The purpose of this paper is to provide precise empirical definitions of financial openness, currency substitution, and dollarization in order to sharpen the discussion and scientific investigation of open-economy monetary policy. Results based on recent experiences of Ecuador and Peru, which have had very different results from stabilization measures in the early 80's, are presented to highlight the importance of careful definition of "stylized facts" when dealing with financial openness, currency substitution, and dollarization.