Dollarization and economic interdependence: the case of Ecuador

Abstract

Economic theory suggest that dollarization increases the degree of interdependence between the dollarized economy and the anchor country. We test this theory for the case of the U.S. and Ecuador. We evaluate the existence of common trends and common cycles amongst production variables. The analysis considers data at the aggregate and industry levels. At the aggregate level, the results show that the economies of the U.S. and Ecuador were interrelated prior to dollarization. This interrelation increased after Ecuador adopted the U.S. dollar. At the industry level, we find that synchronization existed between some Ecuadorian industries and the U.S. Gross Domestic Product prior to dollarization. The interdependence increased after dollarization and it is particularly evident for the financial industry. This result is especially important since it shows how the use of a common currency leads to the integration of financial markets in the dollarized economy and economic activity in the anchor country.