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Inflationary Finance, Capital Controls, and Currency Substitution

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  • Tandon, Ajay
  • Wang, Yong

Abstract

This paper studies currency substitution in an environment where agents' inflation tax-evasive demand for foreign money is balanced by the concern for the possibility that the government may impose economy-wide capital controls under which foreign currency transactions are costly. Under the assumption of endogenous beliefs, the results show a persistent demand for foreign money despite efforts by the government to reduce inflation. In addition, the economy can exhibit multiple, Pareto-ranked steady states with different levels of currency substitution. The stability analysis suggests that the economy converges to the inferior steady state, on the "wrong side" of the Laffer curve. Copyright 1999 by Blackwell Publishing Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of International Economics.

Volume (Year): 7 (1999)
Issue (Month): 4 (November)
Pages: 597-612

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Handle: RePEc:bla:reviec:v:7:y:1999:i:4:p:597-612

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0965-7576

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Cited by:
  1. Antoine Martin, 2002. "Endogenous multiple currencies," Research Working Paper RWP 02-03, Federal Reserve Bank of Kansas City.
  2. John Duffy & Maxim Nikitin, 2004. "Dollarization Traps," Econometric Society 2004 North American Summer Meetings 456, Econometric Society.

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