Can Dollarization Be Key To Curbing Inflation In Struggling Economies? – OpEd
Inflation is a common enemy to all; it is a relentless threat to the economic stability. Inflation is the most common problem in the struggling economies. Although, challenges such as these persist but policy makers nonetheless come up with innovative ideas and solutions to stabilize their economies, restore the faith of citizens and restore their confidence in the state. One such approach which is considered by some to curb inflation and achieve economic stability is Dollarization.
There is no one specific answer to why inflation is caused? As this is driven by numerous factors such as excessive money supply, currency devaluation, supply chain disruptions and so on. However, if countries are facing any one of the mentioned problems it can be exacerbated by poor monetary policies. In a challenging environment, finding effective ways out is essential, some countries choose to adopt dollarization as a strategy.
Dollarization is the adoption of U.S dollars as the primary currency, this move replaces the local currency. However, while dollarization indicates that it may offer immediate relief from the inflationary pressures and the boom-and-bust cycle of an economy, it also raises questions regarding long term sustainability and the loss of national sovereignty.
This approach is adopted by those countries whose economies have performed disastrously. It is a desperate move to tackle sky-high inflation, this approach either abolishes central bank or the roles and the powers of the central bank is significantly reduced and the monetary policies are no longer made by the national government of the state but the policies are set in the Washington D.C, countries have to be very considerate while foregoing their freedom to set their own rates.
Ecuador adopted the US dollar in 2000, it took this step to stabilize its economy when it was facing difficulties. Oil was a major source of revenue for the Ecuador. Albeit, in the 1980s the price of oil fell significantly. This not only reduced the revenue generated from the oil exports but lead to financial instability. Secondly when it faced decline in its exports, Ecuadorian government began to borrow from abroad to finance its expenditures, increasing its borrowing.
From the 1940s through the 1980s, Ecuador faced series of challenges such as a boarder war with Peru and floods from the El Nino weather phenomenon severely destroyed the agricultural crops. Together these multiple factors created a cycle of economic decline and inflation, this led to Ecuador adopting the US dollar currency & stabilizing its economy. In the year 2000 Ecuador experienced significant economic progress as there was reduced inflation, lowered debt ratios. Not to forget that its expanded government intervention and social spending played a crucial role.
Although this proves that dollarization can benefit certain economies which are struggling with high inflation. There are numerous effects of dollarization which help to save the economy.
- Stabilizing Currency
It can curb hyperinflation by introducing a stable currency, this stabilization may contribute to confidence in the economy which may further encourage consumer spending & investment.
- Trade Opportunities
Stable currency enhances trade opportunities, it allows foreign investors to engage more.
- Strategic Planning
A stable currency allows for better long-term planning, businesses either they are national or international.
- Reduced Risks
A stable currency frees an economy with the problem of fluctuating exchange rates.
While Dollarization offers several advantages to save the economy, it is also important to consider the potential drawbacks which are associated with this strategy before implementing it.
- Policy Constraints
Countries could lose its national sovereignty as its monetary policies would be decided in the Washington rather than in their own capitals.
- Economic Shocks
The lack of control may make it difficult to respond effectively to economic fluctuations & crisis.
- Problem of no central bank US reserves
If a state has no US reserves, then it limits their access to the global capital markets, this blocks their access to global capital markets.
- Social & Political Resistance
Citizens & businesses of the state would be accustomed to national currency, their reserves would make them resist the change due to perceived loss of sovereignty.
These challenges highlight the complexity of dollarization. There is a careful need to understand these challenges before adopting such strategy.
On one hand dollarization can contribute to economic stability and can foster a predictable economic environment which may attract investors and facilitate trade. However, the loss of monetary policy control is a significant drawback, meaning change of policy in the US could directly have adverse effects on the dollarized country. Albeit, it can address inflation in the short term but wholly it does not inherently solve economic issues such as fiscal mismanagement, corruption, political instability or even lack of trained ministers or competitiveness. It is very crucial for policymakers to carefully consider these factors & explore other alternatives before taking a huge step.
Concluding that dollarization presents both opportunities and challenges for economies who are struggling with hyper-inflation. However, adopting a stable currency can offer benefits but these benefits might come with certain challenges as well. Ultimately, dollarization can be a sustainable solution it all depends upon the context of each country. Dollarization remains a compelling but a complex option as countries explores ways to combat inflation & achieve economic stability.