Full dollarization versus monetary union: the case of Ecuador

This study proposes using optimum currency areas (OCA) as a theoretical basis for analysis of the full dollarization of Ecuador, viewing the country and the United States as an informal monetary union. At least two facets of this are of interest: (i) the convergence properties of inflation rates between Ecuador and the United States; and (ii) the degree of vulnerability of the Ecuadorian economy to changes in United States monetary policy. Unit roots and stationarity tests are used to study inflation rate convergence, structural vector autoregressive models are used to examine the Ecuadorian economy’s vulnerability to changes in United States economic policy. We find evidence that inflation rates are converging ex-post the full dollarization of Ecuador and that monetary policy changes by the United States do therefore affect Ecuadorian macroeconomic variables. Moreover, we argue that OCA theory is potentially useful for studying fully dollarized economies.