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

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.