IV Congreso Anual Asociación de Economía del Ecuador
The Case of Ecuador
Juan Pablo Erráez & Juan Lorenzo Maldonado
Cuestiones Económicas · Banco Central del Ecuador · December 2025
The views expressed are those of the authors alone.
Read the full paper
Presentation Structure
Hierarchies, endogenous money creation, and the dollarization constraint.
Institutional setup, dual currency, primary money creation, CBE financing, cross-holdings, and fiscal-monetary links.
Five key takeaways and implications for policy, analysis, and investment.
Mehrling (2012) — Money View
Monetary Hierarchy
What counts as money depends on where one stands in the hierarchy: each layer is money below, credit above.
Dollarization fixes the apex constraint: Ecuador can use dollars as ultimate money, but cannot issue them.
Balance Sheet Mechanics — McLeay & Thomas (2014)
Banks don't lend savings — they create deposits. A new loan expands both sides of the balance sheet simultaneously.
New broad money is created without altering the stock of central bank money. The bank generates deposits at the moment of lending — no intermediation of existing resources.
Ecuador — Institutional Context
Private sector became net HPM supplier only in 2024 — historically the public sector dominated. Whether this reversal is permanent is the central open policy question.
Ecuador's Monetary System — Dual Currency & Primary Money Creation
Two Tiers of Money
Externally usable dollars. Scarce, finite, and governed by balance-of-payments flows.
Domestic money. Useful onshore and expandable through balance sheets.
HPM Sources
BoP Inflow → Domestic Money Creation
IR are already inside the economy: each inflow creates a matching domestic liability; each outflow destroys deposits alongside reserves.
Risk Channel 1 - Central Bank Financing
It is the legal framework that prevents a central bank from creating deposits in favor of the government.
Fiscal Monetization Mechanism
The central bank adds a government asset to its balance sheet.
A new public-sector deposit is created as a CBE liability.
The public deposit moves into private bank reserves.
Banks credit households and firms with new deposits.
Net result: M2 expands without a BoP inflow. No new green dollar entered; yellow dollars multiplied.
Risk Channel 2 — Cross-Holdings
When Bank A buys a certificate issued by Bank B, reserves move between banks while the receiving bank creates a new deposit. A reciprocal operation repeats the effect in the opposite direction.
Cross-holdings can inflate M2 and liquidity indicators without new balance-of-payments inflows, obscuring the origin and quality of domestic money.
Example from Section 3.2.2
Initial state: both banks hold excess reserves at the BCE.
Bank A invests 200 in a Bank B certificate.
Bank B reciprocates and invests 200 in Bank A.
Net result: M2 rises by 400 while system-wide BCE reserves stay unchanged. These are yellow dollars created by accounting links, not new green dollars from the balance of payments. The operation is bounded by excess reserves and the reserve requirement ratio: max leverage = 1/r.
Risk Channel 3 — Fiscal-Monetary Link
Domestic public financing and spending move deposits, bank reserves, and pressure on HPM even when no new green dollars enter through the balance of payments.
From Fiscal Operation To Monetary Pressure
Deficits inject spending; consolidation withdraws purchasing power.
BCE, banks, and the Treasury reshuffle reserves and deposits.
M2 can rise or fall before the external constraint is visible.
More domestic dollars eventually test the stock of green dollars.
Domestic deficit finance can raise deposits and liquidity indicators without a matching BoP inflow.
M2 rises before the constraint bites.Spending cuts or tax increases can contract deposits, reserves, and domestic payments capacity.
Liquidity falls even without de-dollarization.The sustainability test is whether domestic money growth is backed by durable HPM sources.
Green-dollar adequacy becomes the anchor.Bottom line: under dollarization, fiscal and monetary dynamics cannot be separated. The public balance sheet helps determine both domestic liquidity and external fragility.
Diagnostic Questions
After the three risk channels, the issue is not only whether M2 expands. The diagnostic task is to identify which HPM source backs domestic claims, how stable that source is, and who manages access to green dollars.
Sustainability
The public sector has been a key provider of HPM through oil revenues and external debt. A fiscal transition can reduce that impulse and tighten domestic liquidity.
Institutional Anchor
The BCE centralizes access to international settlement money, giving banks system-wide access to HPM rather than forcing each bank to self-insure in isolation.
Reserve Adequacy
Official IR alone misses a large part of usable HPM. In dollarization, adequacy depends on broad reserves and the flow dynamics that replenish or drain them.
Reading rule: treat domestic money as a claim on HPM. The relevant policy question is whether the claim is backed by durable green-dollar sources or only by domestic balance-sheet expansion.
Conclusions
BoP and domestic monetary system are codependent.
Primary money creation through external transactions fundamentally shapes the capacity for domestic credit expansion and, by extension, economic growth.
Dollarization does not prevent monetization — legislation does.
Ecuador 2009–2021 proved that a fully dollarized central bank can finance fiscal deficits. The regime itself offers no automatic protection.
Cross-holdings and domestic-debt spending inflate M2 without HPM backing.
Distorting indicators, generating illusory liquidity, and amplifying systemic fragility.
Private-sector HPM generation becomes a monetary imperative.
As public flows from oil and external debt decline under fiscal consolidation, the transition must be purposefully managed.
Reserve adequacy must be measured with Broad IR and dynamic flows.
Official IR alone understates HPM by ~48% in Ecuador. Static adequacy metrics miss the system's self-regulating logic.
Thank you
The Case of Ecuador
Juan Pablo Erráez & Juan Lorenzo Maldonado
Cuestiones Económicas · Banco Central del Ecuador · December 2025
The views expressed are those of the authors and do not necessarily reflect the official positions of any institution.
Full paper — Cuestiones Económicas
Central Bank of Ecuador · 2025
View this presentation online
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