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© 2022 International Monetary Fund
WP/22/234
IMF Working Paper
Western Hemisphere Department
Central Bank Balance Sheet Expansion in a Dollarized Economy: The Case of Ecuador
Prepared by Juan-Pablo Erraez and Julien Reynaud1
Authorized for distribution by Ceyda Oner
December 2022
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Abstract
A textbook argument in favor of adopting another country’s legal tender is that it imposes strong constraints on money creation and therefore fiscal dominance. In Ecuador, an officially dollarized economy since January 2000, a series of accounting practices and subsequent changes in legislations approved over the period 2009–2014 allowed an expansion of the Central Bank of Ecuador’s (CBE) balance sheet to finance the central government. At its peak, central bank financing of the government represented 10 percent of GDP. This resulted in large liabilities to the CBE that translated into low reserve coverage, putting the public and private financial systems and ultimately the dollarization regime at risk. In this paper, we first present the legal and accounting processes behind the expansion of the CBE’s balance sheet and some stylized facts. In the second section, we establish a stress test-like methodology to show how the expansion of the CBE’s balance sheet induced strong pressures on CBE’s liquidity. Ultimately, such liquidity stress at the CBE translated into high cash inflows needs, i.e. external debt, for the central government.
| JEL Classification Numbers: | E42; E51; E58; H81 |
| Keywords: | Central bank; balance sheet expansion; fiscal dominance |
| Author’s E-Mail Address: | jerraez@imf.org; jreynaud@imf.org |
| JEL Classification Numbers: | E42; E51; E58; H81 |
| Keywords: | Central bank; balance sheet expansion; fiscal dominance |
| Author’s E-Mail Address: | jerraez@imf.org; jreynaud@imf.org |
Contents
ABSTRACT
I. THE ACCOUNTING AND LEGAL MECHANISMS FOR CENTRAL BANK BALANCE SHEET UNDER OFFICIAL DOLLARIZATION AND BALANCE SHEET EXPANSION
II. STRESS TEST ANALYSIS
III. CONCLUSION
BOXES
1. Forms of Money in Ecuador and their Acceptance as International Payments
2. CBE’s Balance Rules
FIGURES
1. Money Forms
2. CBE Balance as Reserve Bank
3. Domestic Investment Mechanism
4. Direct Operations with Central Government
5. Internal and External Transactions
6. Impact on CBE’s Liquidity Ration
7. Results of the Stress Test: Heat Map
8. Alternate Results of the Stress Test: Heat Map
We thank Ceyda Oner, Vu Chau, Marina Conesa Martinez, Cecilia Melo Fernandes for helpful comments. We are grateful to our counterparts at the Ministry of Economy and Finance and the Central Bank of Ecuador for constructive comments. We also thank Kristine Laluces for editing support. The usual disclaimers apply.