El Salvador's 2001 dollarization and the end of the colon

From 1993 through 2000, El Salvador ran a pegged exchange rate, with the colon trading at a fixed 8.75 to the US dollar, before the government went a step further and eliminated the domestic currency altogether. Under the Ley de Integracion Monetaria, the US dollar became legal tender alongside the colon from January 2001, and Banco Central de Reserva de El Salvador was required to exchange colones for dollars at the fixed rate until the colon effectively disappeared from circulation. An IMF staff study of the regime found that dollarization lowered El Salvador's commercial lending rates by an estimated four to five percentage points relative to what the earlier pegged-but-not-dollarized regime would have implied, by eliminating the currency-risk premium investors had attached to colon-denominated debt, generating meaningful annual interest savings for borrowers. The tradeoff was a near-total loss of independent monetary policy: Banco Central de Reserva can no longer set interest rates, act as lender of last resort by printing currency, or allow the exchange rate to absorb external shocks, leaving fiscal policy and reserve buffers to do work that monetary policy would otherwise perform in a country with its own currency.