Dominican Republic needs banking and tax reform

After a bungled bank bailout in the Dominican Republic, Steve Hanke of the Cato Institute says president-elect Leonel Fernandez must embrace a bold set of reforms to enhance the confidence of the people in the government.

The scale of the Dominican Republic's economic woes is substantial, says Hanke:

In 2003, the economy shrank for the first time since 1990 and inflation has jumped to 42.7 percent, up from 10.5 percent the year before.

The government has bailed out a number of its banks, costing a staggering 15 to 20 percent of the country's gross domestic product.

To restore confidence and reverse its downward spiral, the Dominican Republic should implement major reforms including at least one of the following:

Adopt a currency board (a monetary authority that maintains a fixed exchange rate with a foreign currency - such as the U.S. dollar - but which cannot act as a lender to the government or banking sector).

Replace the peso with the U.S. dollar.

Establish a free-banking system, whereby banks are allowed to issue their own notes or U.S. currency rather than rely on government-issued notes. Hanke says these dollar-based options would separate monetary and fiscal functions and ensure both stable money and a hard budget constraint. Also, he notes these options would be most effective if the central bank were completely eliminated.

Source: Steve H. Hanke, The Dominican Republic: Resolving the Banking Crisis and Restoring Growth, Cato Institute, July 20, 2004.

For text http://www.cato.org/pubs/fpbriefs/fpb83.pdf

For more on International Currency Issueshttp://www.ncpa.org/iss/int/

FMF Policy Bulletin/ 09 November 2004