Macroeconomic determinants of remittances for a dollarized economy: the case of El Salvador

Purpose - Traditionally, remittances have been analyzed in the context of their socioeconomic impact on the receiving communities. Consequently, little is known about the macroeconomic factors that influence their behavior. This paper aims to evaluate the importance of several macroeconomic indicators on the flow of remittances from the USA to El Salvador. Design/methodology/approach - The analysis considers cointegration and common cycle tests. It includes as explanatory variables gross domestic product (GDP) and the interest rates differential in El Salvador, employment in California, and M2 as a measure of the stance of US monetary policy. These variables are intended to capture macroeconomic conditions in the host and home countries. Findings - The study finds that all variables share a common trend and a common cycle with remittances; though the association with the interest rates differential in the short‐run is weak. That is, remittances respond significantly to transitory and permanent changes in macroeconomic conditions. El Salvador's GDP is negatively associated with remittances, while employment, the interest rates differential, and M2 exhibit a direct relationship at both time horizons. Practical implications - Understanding how macroeconomic conditions influence the supply of US dollars via remittances is fundamental for policy makers in a dollarized economy. In the absence of tools to implement discretionary monetary policy, officials in El Salvador can benefit from learning how the flows of US dollars to the economy respond to macroeconomic shocks. Originality/value - Analyzing the macroeconomic determinants of remittances for a dollarized economy is a novel exercise. Furthermore, the combined long‐ and short‐run approach allows recognizing how macroeconomic conditions influence this capital flow in the steady state and during transitory episodes.