Following the economic crises of the late 1990s, during which Ecuador suffered a series of bank failures and faced the prospect of hyperinflation, the Central Bank of Ecuador (BCE) officially adopted the U.S. dollar as the official Ecuadorian currency. As a result, the CBE effectively relinquished its traditional role in the formulation and application of monetary policy to the Federal Reserve of the United States, although it retained certain other central bank functions, such as statistical compilation and reporting, maintaining banking system liquidity, and serving as the depository for public funds. However, under the dollarization scheme, the key aspects of the International Monetary Fund's Code of Good Practices on Monetary Policy are implemented by the U.S. Federal Reserve. As long as the dollarization appears credible, Ecuador is therefore assigned the level of compliance of the United States for the monetary policy standard.

General Overview

Ecuador suffered a severe financial crisis in the late 1990s. In 2004, the International Monetary Fund (IMF) released a special report dealing with crisis, in which it explained that at the heart of the crisis was the collapse of the banking system, leading to upheaval in both public finance and currency stability. Sixteen of the country's 40 banks failed, and Ecuador was confronted with the very real prospect of hyperinflation. One important stratagem to recover from this crisis was to replace the discredited national currency, the sucre, with the U.S. dollar. In a 2000 Letter of Intent to the IMF, the government of Ecuador announced the passage of the Fundamental Economic Transformation Law in March of 2000. The letter of intent addressed Ecuador's dollarization plan, which involved the conversion of the sucre to dollars on a 25,000 sucre to US$1.00 basis. Limited sucre coinage would remain viable, subject to full backing by U.S. dollars. The Central Bank of Ecuador (BCE) would retain certain functions, such as banking system liquidity recycling. However, dollarization entailed the surrender of monetary policy autonomy, which now fell under the authority of the United States Federal Reserve Board.

Author M. Ullrich, writing for the Center for Latin American Monetary Studies in 2002, noted that Ecuador's monetary and banking laws had to be significantly modified to establish the dollar as Ecuador's legal currency, permit the nation's banks to conduct transactions and accounting in dollars rather than sucres, convert all sucre-accounts to dollar accounts, and achieve other, related ends. Other aspects of the legislative framework also needed to be changed, including Ecuador's Company Law, the law governing the stock market, the Central Bank Law, tax laws, labor law, and others. In a 2006 "Selected Issues" report by the IMF, the pros and cons of dollarization were laid out. Ecuador's poor monetary policy track record prior to dollarization had yielded a 40% annual inflation rate, for example. According to the IMF, "so far, dollarization appears to have served Ecuador relatively well. Inflation has converged to international levels and other measures of macroeconomic stability... have improved" (p. 24). Benefits include the potential for greater economic efficiency and private investment, improved insulation from the "destabilizing effects of frequent bouts of political instability" (p. 24), and helped to promote economic growth. On the other hand, Ecuador's inability to pursue independent monetary policy leaves it more vulnerable to external shocks, given the "large share of oil products in export and government receipts... and the volatility of oil prices" (p. 6). The IMF suggested that monetary policy autonomy and flexibility in its exchange rate could be desirable in such a situation. Ecuador's significant deficiencies in the area of fiscal management cause further problems with official dollarization. The Public Information Notice (PIN) published at the conclusion of the IMF's Executive Board's meeting on the 2007 Article IV consultations between the IMF and Ecuador noted that the "real effective exchange rate has been broadly in line with macroeconomic fundamentals. Other indicators of competitiveness, including the healthy performance of non-oil exports, do not point to competitiveness problems under Ecuador's dollarized system."

According to a 2004 article by Carlos Osorio and Katharine Costar posted on the Privacy International website, Ecuador passed its 2004 Ecuadorian Transparency Law to guarantee citizens the right of access to government and financial information. There are some exceptions to this right, however. For instance, the Armed Forces may restrict access to some information. In the main, however, public institutions and any agencies or organizations that benefit from government funding must respond to citizen requests for information within 10 days of receipt. Indeed, the provisions of the law call for a proactive stance with regard to providing public access to information, including internet access, and the type of information to be provided ranges from bylaws and regulations to staff salaries, budgets and audit results, agency directories, plans, contracts, and other data. Ecuador is a subscriber to the IMF's Special Data Dissemination Standard (SDDS) and posts its monetary metadata on the SDDS website. According to the SDDS website, Ecuador meets all requirements of timeliness, coverage, and periodicity in its monetary data.

The Principles

Clarity of roles, responsibilities and objectives of central banks.

FC

The IMF's 2004 report noted that the BCE's 1992 charter conferred on the central bank operational autonomy in the sphere of monetary policy, but failed to provide political autonomy. Instead, private sector interests dominated the BCE's Monetary Board. According to the report, this situation continued until the height of the monetary crisis in 1998. Two out of the board's seven members were direct appointees of private business associations and a third was the appointee of the commercial bankers' association, whereas the board chairman was directly appointed by the president. Two additional members of the BCE board were governmental appointees, and the Minister of Finance also served on the board with full voting rights. Since the majority of these members were generally drawn from the banking sector, the potential for conflicts of interest was built into the system. The IMF also reported that the BCE was institutionally unstable, citing a one-per-year average turnover rate of its governors. The 1998 Ecuadorian Constitution attempted to address the BCE's problem of politicization by excluding private sector and government representatives from eligibility for board membership. The provisions of the new Constitution called for presidential nomination of board members, followed by a Congressional appointment procedure. These reforms, however, came too late in the run up to Ecuador's financial crisis, and were inadequate to avoid the necessity for dollarization.

According to a 2004 article jointly sponsored by the Center for Latin American Monetary Studies (CEMLA) and the World Bank (WB), dollarization in early 2000 led the BCE to cease many of its traditional functions, including currency issuance, active monetary policy and foreign exchange management, and inflation control. Under the terms of the dollarization scheme, "the amount of money circulating in the economy depends on foreign exchange flows, which in turn is regulated by the arbitrage of the domestic and external interest rates" (p. 1). Ecuador's financial system was thereby fully integrated into the international capital markets. The new primary role for the BCE became the promotion of long-term economic stability.

Writing in 2001, Beckerman noted that dollarization had not totally eliminated the role of the BCE. The BCE would still retain some capability to affect liquidity conditions and to provide assistance to banks experience transitory illiquidity conditions. It still can issue small-denomination coins; hold the reserve deposits of commercial banks; provide limited lender-of-last-resort functions to the government; and maintain the deposit account of the Ecuadorian Treasury. Beckerman observed that dollarization was no panacea for all potential hazards. He notes that, "having lost the option of inflationary accommodation, the public sector could come to rely even more than before on external or domestic borrowing to cope with contingencies, a troubling concern because the public-debt burden remains excessive" (p. 2).

Because of the dollarization of Ecuador's monetary system, which links Ecuador's monetary policy to the U.S. Federal Reserve, and as long as the dollarization appears credible, Ecuador is assigned the level of compliance of the United States for the monetary policy standard.

Open process for formulating and reporting monetary policy decisions.

FC

According to the 2004 CEMLA/WB article, the adoption of dollarization in early 2000 led the BCE to cease many of its traditional functions, including currency issuance, active monetary policy and foreign exchange management, and inflation control. Under the terms of the dollarization scheme, "the amount of money circulating in the economy depends on foreign exchange flows, which in turn is regulated by the arbitrage of the domestic and external interest rates" (p. 1). Ecuador's financial system was thereby fully integrated into the international capital markets. The new primary role for the BCE became the promotion of long-term economic stability.

Because of the dollarization of Ecuador's monetary system, which links Ecuador's monetary policy to the U.S. Federal Reserve, and as long as the dollarization appears credible, Ecuador is assigned the level of compliance of the United States for the monetary policy standard. In a 2005 IMF report on the United States, the IMF found the U.S. Federal Reserve to be highly transparent, though possessing fewer institutionalized monetary policy accountability elements than are found in other industrialized nations. The report added that the Federal Reserve has an enviable record in maintaining price stability. It has increased the frequency with which it explains its policies and expanded the amount of information it provides to the public while reducing the lag time required to produce its reports.

Public availability of information on monetary policy.

FC

According to the 2004 CEMLA/WB article, the adoption of dollarization in early 2000 led the BCE to cease many of its traditional functions, including currency issuance, active monetary policy and foreign exchange management, and inflation control. Under the terms of the dollarization scheme, "the amount of money circulating in the economy depends on foreign exchange flows, which in turn is regulated by the arbitrage of the domestic and external interest rates" (p. 1). Ecuador's financial system was thereby fully integrated into the international capital markets. The new primary role for the BCE became the promotion of long-term economic stability.

Because of the dollarization of Ecuador's monetary system, which links Ecuador's monetary policy to the U.S. Federal Reserve, and as long as the dollarization appears credible, Ecuador is assigned the level of compliance of the United States for the monetary policy standard.

Accountability and assurances of integrity by the central bank.

FC

According to the 2004 CEMLA/WB article, the adoption of dollarization in early 2000 led the BCE to cease many of its traditional functions, including currency issuance, active monetary policy and foreign exchange management, and inflation control. Under the terms of the dollarization scheme, "the amount of money circulating in the economy depends on foreign exchange flows, which in turn is regulated by the arbitrage of the domestic and external interest rates" (p. 1). Ecuador's financial system was thereby fully integrated into the international capital markets. The new primary role for the BCE became the promotion of long-term economic stability.

Because of the dollarization of Ecuador's monetary system, which links Ecuador's monetary policy to the U.S. Federal Reserve, and as long as the dollarization appears credible, Ecuador is assigned the level of compliance of the United States for the monetary policy standard.