Rigidities, and Financial Dollarization

2004 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper stresses three factors that amplified the 1990s financial crisis in Ecuador, namely institutional weaknesses, rigidities in public finances, and high financial dollarization. Institutional factors restricted the government’s ability to respond in a timely manner and efficiently enough to prevent the escalation of the banking crisis and spurred the adoption of suboptimal policy decisions. Public finance rigidities limited the government’s capacity to correct existing imbalances and the deteriorating fiscal stance associated with the costs of the financial crisis. Financial dollarization increasingly reduced the effectiveness of financial safety nets, fostered foreign currency demand, and accelerated a currency crisis, thereby further worsening the solvency of banks. These three factors reinforced each other