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The dynamics of inflation and currency substitution in a small open economy

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Author Info
Miguel Lebre de Freitas () (Departamento de Economia e Gestão Industrial, Universidade de Aveiro)

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Abstract

In this paper, we analyse the relationship between money and inflation in a small open economy where domestic and foreign currencies are perfect substitutes as means of payment. It is shown that, if the path of domestic money supply is such that individuals find it optimal to change the currency in which transactions are settled, there will be an adjustment period during which domestic inflation adjusts so as to equalise the foreign inflation rate. In the case of a disinflation program, it is shown that the foreign currency is not necessarily abandoned as means of payment. The results obtained are consistent with both dollarisation hysteresis and reversibility, without requiring the specification of dollarisation costs.

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File URL: https://www.ua.pt/egi/ReadObject.aspx?obj=10986
File Format: application/pdf
File Function: First version, 2003
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Publisher Info
Paper provided by Departamento de Economia, Gestão e Engenharia Industrial, Universidade de Aveiro in its series Working Papers de Economia (Economics Working Papers) with number 02.

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Length: 27 pages
Date of creation: Aug 2003
Date of revision: Aug 2003
Handle: RePEc:ave:wpaper:022003

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Related research
Keywords: currency substitution; dollarisation; money-demand and hysteresis;

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Find related papers by JEL classification:
E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dowd, Kevin & Greenaway, David, 1993. "Currency Competition, Network Externalities and Switching Costs: Towards an Alternative View of Optimum Currency Areas," Economic Journal, Royal Economic Society, vol. 103(420), pages 1180-89, September. [Downloadable!] (restricted)
  2. Federico A. Sturzenegger, 1992. "Inflation and Social Welfare in a Model with Endogenous Financial Adaptation," UCLA Economics Working Papers 658, UCLA Department of Economics. [Downloadable!]
  3. Uribe, Martin, 1997. "Hysteresis in a simple model of currency substitution," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 185-202, September. [Downloadable!] (restricted)
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  4. Steven B. Kamin & Neil R. Ericsson, 1993. "Dollarization in Argentina," International Finance Discussion Papers 460, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  5. Chang, Roberto, 1994. "Endogenous Currency Substitution, Inflationary Finance, and Welfare," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 903-16, November. [Downloadable!] (restricted)
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  6. Clements, Benedict & Schwartz, Gerd, 1993. "Currency substitution: The recent experience of Bolivia," World Development, Elsevier, vol. 21(11), pages 1883-1893, November. [Downloadable!] (restricted)
  7. Pablo Guidotti & Carlos A. Rodríguez, 1992. "Dollarization in Latin America: Gresham's Law in Reverse?," CEMA Working Papers: Serie Documentos de Trabajo. 81, Universidad del CEMA. [Downloadable!]
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  8. Kareken, John & Wallace, Neil, 1981. "On the Indeterminacy of Equilibrium Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 96(2), pages 207-22, May. [Downloadable!] (restricted)
  9. Federico Sturzenegger, 1992. "Inflation and Social Welfare in a Model With Endogenous Financial Adaptation," NBER Working Papers 4103, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. K C Neanidis & C S Savva, 2006. "The Effects of Uncertainty on Currency Substitution and Inflation: Evidence from Emerging Economies," Centre for Growth and Business Cycle Research Discussion Paper Series 71, Economics, The Univeristy of Manchester. [Downloadable!]
    Other versions:
  2. Miguel Lebre de Freitas, 2006. "Currency Substitution and Money Demand in Euroland," Atlantic Economic Journal, International Atlantic Economic Society, vol. 34(3), pages 275-287, September. [Downloadable!] (restricted)
    Other versions:
  3. Helmut Stix, 2008. "Euroization: What Factors drive its Persistence? Household Data Evidence for Croatia, Slovenia and Slovakia," Working Papers 140, Oesterreichische Nationalbank (Austrian Central Bank). [Downloadable!]
  4. Miguel Lebre de Freitas, 2004. "Currency Substitution, portfolio Diversification and Money Demand," NIPE Working Papers 9/2004, NIPE - Universidade do Minho. [Downloadable!]
    Other versions:
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