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.

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