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HISTORY

The Central Bank of Ecuador is a legal person under public law, part of the Executive branch, of indefinite duration, with institutional, administrative, budgetary, and technical autonomy.

Historical review

The Central Bank of Ecuador was born as a result of the reforms and founding values ​​of the "Revolución Juliana" of July 9, 1925. It became the first and only issuing national bank1 that proposed a way out of the acute crisis that prevailed in the country.

In the opinion of Luis Napoleón Dillon, the economic crisis of the early 20th century was caused by the inconvertibility of the banknote2, the issuing of currency without backing, inflation, speculation, excess lending, and the negative balance of payments. This situation had to be addressed by cleaning up the currency and regularizing the exchange rate. Under these foundational values, the Central Bank of Ecuador (BCE) was created, within a motley set of reforms of the Ecuadorian economy advocated by the military and civilians gathered around the ideas of the revolution and overcoming the inertia of some groups who were not interested in progress in this regard.

As an intermediate step for the founding of the BCE, on June 26, 1926, the Central Issue and Amortization Bank was created, an organization in charge of officially recognizing the total amount of means of payment and provisionally authorizing the circulation of banknotes. In addition, on October 18, 1926, banks authorized to issue banknotes were ordered to deliver to the Central Issue and Amortization Bank certain amounts of gold and silver. Meanwhile, the mission presided by renowned American economist Edwin W. Kemmerer, who enjoyed much fame as a result of similar work done in other countries worldwide, was preparing an extensive set of modernizing economic measures. Among them was the Draft of the Organic Law of the Central Bank of Ecuador, handed by the Kemmerer Mission on February 11, 1927, for consideration by the Government.

This proposal entailed the creation of the BCE as an institution authorized to issue money, rediscount the fixed rate, become a depository for the government and associated banks, manage the exchange market, and act as a fiscal agent. Thus, on March 4, 1927, President Isidro Ayora signed the Organic Law of the Central Bank of Ecuador3; the public deed of incorporation of the BCE is issued on July 9 of that same year (second anniversary of the Revolution), and, finally, on August 10, 1927, the BCE begins operations, this date being considered onward as the date of its foundation.

The initial objectives of the BCE were to stabilize and unify the currency. To achieve this, it used the "gold exchange standard,"4 a monetary regime that fixed the price of the sucre in terms of gold; the basic obligation of the BCE was to keep that price fixed.

This forced convertibility coincided in time with the Great Depression of October 1929, which forced the decree of a payment moratorium on February 8, 1932. From then on, the country entered into a policy of deficit fiscal spending and government credit by the BCE. In this context, Mexican consultant Manuel Gómez Morín was called to reform the Central Bank Law and related monetary regulations. Together with Víctor Emilio Estrada, a prominent Guayaquil banker, Mr. Gómez Morín advised assigning the BCE the central role in determining the types of loans offered by private banks to the productive sector by modifying the discount rate (1937). The difficulties in executing the recommendations of the Gómez Morín Commission were immense. However, from then on, the relations between the government and the banking system were profoundly modified.

A Central Bank for development

After the Second World War, a new upturn in inflation, together with serious balance of payments problems, made the help of foreign experts necessary once again. In 1947, the BCE called Robert Triffin, an illustrious Keynesian economist5 from the Federal Reserve System of the United States. Triffin proposed replacing the Organic Law of the Central Bank with the International Exchange Law (1947) and the Monetary Regime Law (1948). The Monetary Regime Law of 1948 granted the BCE the role of liquidity manager to finance the country's development, which allowed the institution to contribute to the consolidation of the national economy during the Glorious Thirties period6, the one with the greatest monetary stability in Ecuador’s economic history. In addition, the Monetary Regime Law of 1948 set new concepts: a Board of the BCE in which the Government participates; the power to devalue the currency for economic purposes and to execute countercyclical policies; the authorization to grant loans to the State and the productive sector; and, finally, an accounting system that allows it to take up the new duties. This monetary regime successfully faced a series of economic shocks for more than three decades.

External debt crisis and dollarization

The external debt crisis began in the 1980s and broke out in 1981, after the international increase in interest rates in 19797. In addition to the imbalances in the economy, fiscal deficits, monetary devaluation, and overwhelming inflation, there was also internal pressure from the private sector to the Government to solve the existing debt problems. As a result, a renegotiation of the foreign debt and a socialization of the debt of the national private sector took place through the so-called “Sucretization of private debt.”

In addition, with the support of the International Monetary Fund and the World Bank, new changes were made to reorganize the economy as a whole and try to return to a path of growth. With this purpose and under a new economic paradigm8, in May 1992, the Monetary Regime and State Bank Law was issued. It sought to give “autonomy” to the BCE, distancing it from political appointments and decisions by the government; to restrict the use of direct instruments and give greater importance to indirect instruments to guide the exchange and interest rates and thus manage stable levels of inflation; and to prevent the BCE from granting loans to the Treasury. Under this regulatory framework, the country entered into a regime of controlled floating exchange rate, in which the role of the BCE mainly consisted on intervening in the financial system through the money and foreign exchange desks and the auctions of monetary stabilization bonds (BEMs). In addition, this reform authorized the BCE to operate as lender of last resort of the financial system.

The 1992 Monetary Regime and State Bank Law was accompanied by the 1994 General Law of Financial Institutions and the 1998 Constitution, which together completed the autonomy of the BCE and the liberalization of financial markets so that free competition would foster their development. Thus, for example, the 1998 Constitution, in its Art. 261, defines the BCE as a "legal entity under public law with technical and administrative autonomy, [which] will have as its functions to establish, control, and apply the monetary, financial, credit, and exchange policies of the Government and, as its objective, to ensure the stability of the currency." On the other hand, the General Law of Financial System Institutions of 1994 eliminated the figure of intervention by the Superintendency of Banks and Insurance in financial institutions, prioritizing their self-regulation. In 1998, one of the worst financial crises in the country occurred, with the entry of some banks into a process of "financial clean-up" and "restructuring".

The losses of the private banks were socialized as the Government assumed their obligations. The BCE, as lender of last resort, issued sucres inorganically to finance liquidity credits and to enable the Deposit Guarantee Agency -AGD- to pay cash to affected depositors9. The country ended up losing credibility in its currency, which led the Government to declare a bank holiday on March 8, 1999, freezing most of citizens' deposits. Almost a year later, in order to mitigate the growing social unrest, the Government announced the dollarization of the Ecuadorian economy on January 9, 2000. The U.S. dollar replaced the Ecuadorian sucre as legal tender, which serves as a store of value, unit of account, and means of payment. The BCE was left unable to issue currency, except for coins, and with the obligation to exchange the existing sucres for the US dollars it held in its International Monetary Reserve -IMR-, at a fixed exchange rate. This last process ended in June 2001.

Once dollarized, the financial system gradually returned to normal, but it was not until 2004 that deposits and loans returned to their historical levels prior to the 1998 financial crisis.

The Central Bank and its autonomy

With the 2008 Constitution, the BCE ceased to be "autonomous" and became a legal entity under public law responsible for implementing the monetary, credit, exchange, and financial policies formulated by the Executive branch10. The 2008 Constitution also required a comprehensive restructuring of the existing monetary and financial regulations, as well as of the institutions responsible for designing and executing economic policy. In regard to the BCE, it entered into a new structural reform to update its role and meet the challenges it faced.

In May 2021, the Organic Law Reforming the Organic Monetary and Financial Code for the defense of dollarization was approved, which defines the Central Bank of Ecuador as a legal entity under public law, part of the Executive branch, and with institutional, administrative, budgetary, and technical autonomy. It establishes as functions of the institution: guaranteeing that money circulates in the country; overseeing the functioning and health of the economy; preserving and managing the international reserve; and managing the Liquidity Fund Trusts of the Private and Popular and Solidarity Financial Sectors.

With this regulation, the BCE is configured as a technical institution at the service of the country, to fulfill its objective of strengthening dollarization and protecting depositors' money.

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Bibliographic notes

1 The "Suppression of the Law of Inconvertibility of banknotes; establishment of the National Bank to give value to the currency" was the third of the twelve points of the program of the “Revolución Juliana” military. See: Ejército Nacional. (1925). "The twelve points of the Program of the new Regime". Revista de Estudios Histórico-Militares. Year IV. No. 26. Quito-Ecuador, p. 567.

2 In 1914, under the second presidency of General Leónidas Plaza (1912-1916), the Inconvertibility Law or Moratorium Law was enacted, which allowed banks to issue banknotes without gold backing.

3 Official Gazette. (March 12, 1927). No. 283.

4 The Central Bank of Ecuador was created in a context in which economic thought was governed by the gold standard and monetary orthodoxy (neutrality of money) of David Ricardo's (1772-1823) thought. Ricardo's neutrality of money considers that real interest rates are not influenced by currency, instead being determined by the confrontation of the supply of savings and the demand for investment, both real variables. Currency only influences nominal interest rates via inflation and, therefore, its issuance must be limited, respecting the quantitative equation of currency (MV=PQ) created in the 15th century. With respect to David Ricardo, J.M. Keynes in his 1936 work "The General Theory of Employment, Interest and Money" mentions: "Ricardo conquered England as completely as the Holy Inquisition conquered Spain."

5 In the field of economic thought, a heterodox vision of money began to be imposed, led by the British economist John Maynard Keynes (1883-1946). For him, "money is not a commodity but a currency." Monetary issuance should not only be aimed at stabilizing inflation, but also at job creation. If the level of labor in an economy is low, it is necessary to issue currency to dynamize the economy and reach full employment with controlled inflation. For J. M. Keynes' monetary thought, see A treatise on Money (1930) and Proposal for an International Clearing Union (1941).

6 A term used to describe the global development of the period after World War II and prior to the structural consequences of the first oil crisis: 1945-1975.

7 On October 6, 1979, the U.S. Federal Open Market Committee (FOMC) adopts a reform in its interest rate policy to move from gradual interest rate increases to more substantial increases.

8 The Keynesian thinking was preceded by the monetarist counter-revolution led by Milton Friedman (1912-2006) and the Chicago School with the historical concepts of neutrality of money. Under this conceptual framework, Central Banks should cease to be development agents and become "autonomous" institutions dedicated solely to controlling inflation, leaving aside other objectives such as labor, economic growth, and redistribution. They are only allowed to use indirect instruments of action (market instruments) and are prohibited from using direct methods such as directing credit.

9 "The AGD began the cash payment of the deposit guarantee through securities (AGD Bonds) issued by the Ministry of Economy and Finance (MEF) with maturities in 2013 and 2014. The only buyer of these papers was the BCE, through inorganic issuance". (Dirección de Análisis y Política Económica de la Coyuntura. (Jul. 2010). "The Ecuadorian economy after 10 years of dollarization". En Paladines E. (Edit), Dirección General de Estudios del Banco Central del Ecuador, Quito, Ecuador, p.35.

10 Constitution of the Republic of Ecuador. 2008. Art. 303.

11 Official Gazette. (2021). Organic Law Reforming the Organic Monetary and Financial Code for the defense of dollarization.