Abstract

Ecuador has adopted the dollar as its currency; ex-president Menem of Argentina advocates the same. However, ECLAC claims a consensus favoring greater exchange rate flexibility. This paper examines the uncertainty about the correct exchange rate regime and the push toward dollarization. It suggests that the constraints imposed by the "dollar bloc," the informal but powerful currency bloc that ties Latin America to the dominant currency, the dollar, are central to the choice of exchange rate regime. Current weak economic performance has called the norms and principles of the bloc into question and raised doubts about the most effective exchange rate regime. Ecuador's full official dollarization is one possible policy direction for countries with poor economic performance and political instability. Most of Latin America will continue with variants of dirty floats and will face periodic foreign exchange crises that trigger access to official financial flows and facilitate renegotiation of the terms on outstanding debt.

OUTLINE

Introduction

The Centrality of the Dollar in the Western Hemisphere

The Sterling and Franc Currency Blocs

The Mechanisms and Operations of the Dollar Bloc

Mechanisms of the Dollar Bloc

External Claim on Reserves

Existence of a Dollar Pool

External Influence on Macroeconomic Performance

The Effect of the Currency Bloc on Domestic Economic Policy

Control of the Money Supply

Control of the Exchange Rate

Loss Seigniorage

Limits on Capital Controls

The Evolution of the Dollar Bloc

Domestic and International Policy Initiatives and Conflicts

The Dollar Bloc and Democracy in Latin America

The Dollar Bloc, the European Monetary System, and the Yen

Conclusions