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Hyperinflation with Currency Substitution: Introducing an Indexed Currency

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  • Federico Sturzenegger
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    Abstract

    Currency substitution (CS) and financial adaptation are in general believed to increase the equilibrium rate of inflation. This result derives from a setup in which the government finances a certain amount of real resources through money printing and where CS reduces the base of the inflation tax. This paper shows this intuition wrong for those situations where the hyperinflation is expectations-driven. Incorporating CS in an Obstfeld-Rogoff (1983) framework I show reduces the inflation rates along the hyperinflationary equilibrium. The intuition is simple: if agents have an easy way of substituting away from domestic currency then the required inflation rates to sustain a path where real balances disappears is necessarily lower. The implications of the model are then tested empirically.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4184.

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    Date of creation: Oct 1992
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    Publication status: published as Journal of Money, Credit and Banking, August 1994
    Handle: RePEc:nbr:nberwo:4184

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    1. Dornbusch, Rudiger & Reynoso, Alejandro, 1989. "Financial Factors in Economic Development," American Economic Review, American Economic Association, vol. 79(2), pages 204-09, May.
    2. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
    3. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March.
    4. José De Gregorio, 1991. "Welfare Costs of Inflation, Seigniorage, and Financial Innovation," IMF Staff Papers, Palgrave Macmillan, vol. 38(4), pages 675-704, December.
    5. Liviatan, Nissan, 1981. "Monetary Expansion and Real Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1218-27, December.
    6. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-70, August.
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