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Twin Deficits and External Constraints in a Dollarized Economy: A Stock-Flow Consistent Exercise for Smaller Economies with an Application to El Salvador

Author

Listed:
  • Armando Alvarez
  • Esteban Perez-Caldentey
  • Giuliano Toshiro Yajima

Abstract

This paper develops a stock-flow consistent (SFC) exercise for a smaller and dollarized economy and applies it to the case of El Salvador. Against the backdrop of the 2025 IMF-supported fiscal adjustment program, we reassess the origins of rising public debt and persistent external deficits within a unified sectoral balances framework. In particular, we show the importance of remittances and terms-of-trade effects to capture the structural determinants of the Salvadorian economy. We then reassess the impact of the IMF program within our framework. As exemplified by the case of El Salvador, smaller economies are characterized by persistent twin deficits. Within a stock-flow consistent framework, this sets the stage to analyze the dynamics of the economy of El Salvador in terms of the interaction between the fiscal stance and foreign trade performance ratio. The analysis underscores the centrality of the external constraint in shaping growth and debt trajectories and offers a coherent macro-financial framework for evaluating policy trade-offs in dollarized economies.

Suggested Citation

  • Armando Alvarez & Esteban Perez-Caldentey & Giuliano Toshiro Yajima, 2026. "Twin Deficits and External Constraints in a Dollarized Economy: A Stock-Flow Consistent Exercise for Smaller Economies with an Application to El Salvador," Economics Working Paper Archive wp_1123, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_1123
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    References listed on IDEAS

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    1. Michalis Nikiforos & Laura Carvalho & Christian Schoder, 2015. "“Twin deficits” in Greece: in search of causality," Journal of Post Keynesian Economics, Taylor & Francis Journals, vol. 38(2), pages 302-330, October.
    2. Marco Missaglia, 2021. "Understanding Dollarisation: A Keynesian/Kaleckian Perspective," Review of Political Economy, Taylor & Francis Journals, vol. 33(4), pages 656-686, October.
    3. John Maloney, 2012. "The Treasury and the New Cambridge School in the 1970s," Cambridge Journal of Economics, Cambridge Political Economy Society, vol. 36(4), pages 997-1017.
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    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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