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Dollarization
Frequently Asked Questions
Dollarization is a regularly discussed topic in both Curaçao and Sint Maarten. The CBCS aims to provide some insights and address a few of the most frequently asked questions.
Curaçao and Sint Maarten have a common currency, the Netherlands Antilles guilder (NAf), that is pegged at a fixed rate of 1.79 guilders to the US dollar. This means the exchange rate regime is a conventional peg, unlike floating exchange rates. In this system, the value of the currency isn't determined by market forces like supply and demand.
Thus, the main objective of the CBCS’s monetary policy within its conventional peg system is to preserve the external value of the guilder to the US dollar, i.e., keeping the exchange rate unchanged at NAf 1.79 for US$ 1. As will be the case with the Caribbean guilder once introduced.
There are advantages and disadvantages to maintaining an own currency. The advantages of an own currency are an independent monetary policy, being a lender of last resort for commercial banks in case of liquidity shortages, and the income derived from minting one’s own currency (seigniorage). The main disadvantage of an own currency is that there are transaction costs involved when we exchange our currency into US dollars for our trade and capital flows. With dollarization, these transaction costs are eliminated.
Since most of our international transactions are in US dollars, an advantage of the peg is that trade and capital transactions are better facilitated since exchange rate uncertainties are reduced compared to a floating exchange rate.
However, because of the fixed peg of the guilder to the dollar, the tools for independent monetary policy are limited.
Dollarization is always an option. Deciding to dollarize should however come after serious public discussion on how to implement it in an orderly and responsible manner. Nevertheless, the ultimate decision should be based on sound macroeconomic fundamentals. Given the existing price stability for more than 50 years, monetary policy credibility under the conventional peg, and the fiscal discipline imposed through law (i.e. Kingdom Law on Financial Supervision in Curacao and Sint Maarten), there seems to be no compelling reason at this moment to opt for dollarization.
If the countries opt to dollarize, an independent monetary policy will no longer exist, which means the end of the monetary union. Furthermore, with the disappearance of the guilder to the dollar peg, the need to keep sufficient foreign reserves of US dollars to preserve the guilder’s value and ensure smooth international transactions would also be eliminated. This means that the central bank would lose its ability to function as lender of last resort in the case of a banking crisis.
Even though the monetary union would no longer exist in the case of dollarization, the CBCS could continue in its capacity as supervisor of the financial sector as well as overseeing an effective and sound payments system. In addition, the CBCS could continue advising the governments on economic matters.
Either country in the monetary union can dollarize independently of each other if its authorities decide to do so, but it means that the monetary union will dissolve. If one of the two countries decides to dollarize while the other chooses to keep its own currency, i.e., the Caribbean guilder, then the country that dollarizes will forego an independent monetary policy, among other things.
The dollarized country may then choose to maintain an independent central bank after dollarization. In general, the tasks and functions assigned to central banks in an officially dollarized regime may include (1) financial sector supervision; (2) issuance of prudential and supervisory regulations; (3) handling of cash currency; (4) management of international reserves; (5) provision of clearance function for the payments system; (6) serving as fiscal and financial agent of the government; and (7) conducting macroeconomic studies and advising governments on macroeconomic topics.
Dollarization results in a loss of seigniorage income. Seigniorage is the profit a country makes from issuing its own currency, i.e., the difference in the cost of producing it versus its face value. There would also be the loss of the license fee income for both countries’ governments.
Moreover, there would be a loss of monetary policy independence (albeit limited in our case) and the loss of lender-of-last-resort function. These are not monetary costs per se, but they are considered part of the costs or losses from dollarization.
The short answer is no, inflation will not increase if the process of dollarization is managed prudently.
Sometimes, the spike in prices after adopting the US dollar as official currency may occur because of so-called currency rounding, a process whereby sellers simply convert the price of a good or service from the domestic currency to the US dollar without properly applying the rate of exchange.
For example, if a soda costs NAf 1.80 and the price is converted to US$1.80, that would be a case of currency rounding and drives up prices. The correct way would be to adjust the price of the soda to US$1.00 to reflect the official exchange rate.
Currency rounding can be avoided through proper preparation and legislation before official dollarization occurs.
For more detailed information and in-depth analysis on the topic, we encourage you to download and read the CBCS’s paper on dollarization, titled “Position Paper: Dollarization as possible exchange rate system in Curaçao and Sint Maarten.” that can be found here.
Last updated: 04.10.2024 17:10